INV3703/103/2/2018

Tutorial Letter 103/2/2018

Investments: Derivatives
INV3703

Semesters 2: Assignment 02

Department of Finance, Risk Management &

Banking

IMPORTANT INFORMATION
Please register on myUnisa, activate your myLife e-mail addresses and
make sure that you have regular access to the myUnisa module
website, INV3703-2018-S1/S2, as well as your group website.

Note: This is an online module and therefore it is available on myUnisa. However, in order to
support you in your learning process, you will also receive some study material in printed
format.

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1 INSTRUCTIONS FOR ASSIGNMENT SUBMISSIONS

Please take note that the assignments do not contain any unique numbers. You can only submit
this assignment by uploading your answers by making use of the file upload function.

Step-by-step instruction:
- Access the assignment;
- View the question;
- Follow the instructions to upload a document; and
- Upload your answers.

2 ASSIGNMENT 02 QUESTIONS

Question 1
Consider an asset that trades at $100 today. Call and put options on this asset are available with
an exercise price of $105. The options expire in 275 days, and the volatility is 0.45. The
continuously compounded risk-free rate is 3%. The asset has a dividend yield of 0.5%.
If N(d1) = 0.5478 and N(d2) = 0.3936 calculate the following:
1.1 Calculate the value of the European call option. [2]
1.2 Calculate the value of the European put option. [2]

Question 2
Consider a one-period binomial model in which the share currently trades at R70. The share
price can go up 15% or down 15% each period. The risk-free rate is 5%. A put option on this
stock expiring in one period has an exercise price of R75.
2.1 Calculate the number of units of the underlying share that would be needed at time 0
in the binomial tree in order to construct a risk-free hedge. Use 500 puts. [6]
2.2 Which position would you take in order to construct this risk-free hedge? [1]

Question 3
An asset manager wishes to enter into a two-year equity swap in which he will receive the rate of
return on the FTSE 100 equity index in exchange for paying a fixed interest rate. The FTSE 100
equity index is at 1510 at the beginning of the swap. The swap has a notional principal of £5
million and calls for semi-annual payments. Assume a 360-day year. The current term structure
of interest rates is:
180 0.0480
360 0.0580
540 0.0640
720 0.0690

3.1 At the initiation of the swap contract, what is the value of the swap? [1]
3.2 Calculate the annualized fixed rate on the swap. [5]

2
 INV3703/101/3/2018

Ninety days later the FTSE 100 equity index is at 1608 and the term structure of interest is:
0 90 0.0499 180 0.9877
270 0.0592 360 0.9575
450 0.0651 540 0.9247
630 0.0658 720 0.8967
3.3 Calculate the present value of the remaining fixed payments. [2]
3.4 Calculate the value of the equity payment. [1]
3.5 Calculate the market value of the swap and state whether the fixed is paid or received.
[2]

3 CONCLUSION

Do not hesitate to contact us by e-mail, if you experience problems with the content of this tutorial
letter or with any academic aspect of the module.

Mr C Erasmus
Lecturer for INV3703
DEPARTMENT OF FINANCE, RISK MANAGEMENT AND BANKING

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