BUS 425 - Global Financial Risk Management — Sample Exam TIT Professor Koch Covers: Hull, Chapters 9, 11, 12, 15, 18. Answer all questions. Points assigned to each problem appear in parentheses. 90 points possible. 1. Is each statement is True, False, or Uncertain? Explain your answer in each case. Teut Fare O A ne putts & calls cannot be more valuable than the present value of K. 7 Pek; ps Ker c$CSS bt Tmay be > Ke" (©) B. European calls and puts can be accurately valued using the Black/Scholes model, although American calls and puts cannot. Falié ~ American cals can if ne dividend European calls & ptr can, CAnerican pute cannet) (©) C.. The risk-neutral ica rinciple trols kv ae a Aa pe ee using implied volatility. Defixe risk neutral valuatien & implied volatile) Fale —nonsense- < ve can value American pute with Binomial Medal 2. A. Suppose that the current stock price is S = $45; ©) 8 one-year European put option with a strike price of K = $50 costs p = $9; and the riskfree rate is 10% (thus, Ke" = $45.24). What is the equilibrium value of a one-year European call on this stock (c) with the same exercise price, implied by Put-Call Parity? Supaker™e Cs C= 4p Ke = 4549 - 15a = fe Te (© — B. I imaddition to the information in A. above, you observe that the call ‘| currently selling for c= $9.50, discuss possible arbitrage opportunities. <~CC13 Steck, pit, berm) Sell call for 9.52 5 buy syrthets te call for §,76 5 keep AAP —Te 3. Assume that the one-period Binomial Option Pricing model holds, where the time period is one year (At= I year), the initial stock price is Sp = $50, and the final stock price, Si, either increases to uSp = $60 (u=1.2) or decreases to dSy = $40 (d=.8). the (©) A. _ Ifthe exercise price of a call option on this stock is K = $45, what value of this call option at expiration: (if So increases; [js] (ii) if Sy decreases? (6) B. What is the hedge ratio for this stock (the number of shares of stock purchased per call written that makes the — tiskfree)? A= COu-Cad/CSu-Sd = (15-0) / C60 —40) (6) C. Ifthe riskfree rate is r= 9.54% (e'"=1.10), what is the value of option at the beginning of the period? pacers —a\/Cu-d) = (Mo~.8)/CL2~.3) = 275, c= LhisCrs)+Fo¢as\] /110 (6). — Now assume that the two-period Binomial Option Pricing model holds (n=2), with all other information identical to that above (At = 1 year, S = $50, u= 1.2, d= .8, K = $45, and r = 9.54%). What is the value of this call option at expiration (after 2 periods) (i) if So increases twice; Cau= max EF Su KOR = 72-45 =|h27 (ii) if So increases once and decreases once; Cub = rex FSud-X 0 (iii) if So decreases twice? Ca = wax Stk 03= 32-46 is calFin) 425 Sample be. Oe Cons, 446) A. _ Discuss what happens to delta when expiration approaches, for: © cy © 6) @ an in-the-money call option; St phabiily ite) Gi) an outof-the-money put option. 5G P Suppose the delta of a call option is (.20), and the delta ofa put option on the same underlying asset is (-.68). Explain in detail how fo construct a delta- neutral hedge for a long position in one unit of the underlying asset: Sucectenn sd tye Yyele ele | (ii) using put options. — uy Vee Ve =| 147_ pits Consider a $300,000 investment in gold, and another $500,000 investment in silver. Suppose the daily volatilities of gold and silver returns are .018 an 02, respectively. [This means that the Gan) Car of the daily change in th¢gold jnvestment, for example, 0 ae is $300,000*(.018) £8: > B Scocmp (012) ¥eac\ Ragen $28,176 of 31,307 ‘A. Whatis the 95% I-day VaR for the gold investment? .65 * #5402 ‘What is the 95% 1-day VaR for the silver investment? |. ¢5 x #6, oo =| B. What isthe 95% 10-day VaR for the gold investment? [65° #5, 40 X sto ‘What is the 95% 10-day VaR for the silver investment? ) 5x. $¢¢,aw x-Jio = C. Consider a portfolio consisting of both the gold and silver investments above. Suppose the correlation between daily retums in gold and siver is p=.6. ‘What is the 95% 1-day VaR of this joint investment? What are the benefits of diversification? | ‘That is, by how much does diversification reduce the 95% I-day VaR LL. of this joint investment below the VaR's of the two investments separately? 6. (6) Briefly explain why the linear model can provide only approximate estimates of VaR Ce for a portfolio containing options Options have nonlinear payee; linear model iqneres curvature C& gemma) — only gives ‘approx mation M10 200 Thus 1% rdey VeR = 165% Bioaw = (Biz,s20) Benefits = Vari) + VarG) — Var (uty) ba = tyqo + #970 — #832 = fizz 2 2 Ae Taw=(G ears 2 eng] = [Stoo + bam*+ 264) (S40d)Cow) 4% i