Introduction To Derivatives And Risk Management 10th Edition Don M. Chance, Robert Brooks - Solutions

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Again using the DHS model, suppose that Î¸=1; =1; =2; =1; and s1=2. Describe and comment on the path of prices when overconfident investors determine prices vs. the rational path of prices.
Momentum is the anomaly that gives those subscribing to efficient markets the most trouble. Explain.
An individual with cash to invest has two investment choices:Buy a stock fund which every year either earns 40% or -20% with a 50/50 probability.Buy a bond fund which every year returns either 5% or 0% also with 50/50 probability.Assume that the returns on the two funds are independent, and that
What do experimental bubble markets teach us about the likelihood of bubbles in the real world? In what sense does this research have its limitations?
Differentiate the following terms/concepts:a. Clienteles and cateringb. Dividend payment and home-made dividendc. Investor sentiment and irrationalityd. Synergy and valuation consequences of a merger
One of John Lintner's conclusions in his classic study of dividend policy is that managers do not seem to change dividend payment in response to capital requirements for new investment (Lintner, J., 1956, "Distributions of incomes of corporations among dividends, retained earnings and taxes,"
Suppose a particular investment is believed by management to be a negative-NPV undertaking, but many shareholders believe otherwise, holding the view that investments of this type are value-creating. What should be done? Discuss in the context of the heuristic model presented in the chapter.
A company has 1,000,000 shares outstanding trading at $15 apiece. Managers believe that the discount rate appropriate for the risk borne is 15% and total cash flows, expected to be $1 million next year, will rise by 5% per year indefinitely. Discuss a strategy that is beneficial to the current
Differentiate the following terms/concepts:a. Payback and NPVb. Holding in-the-money options too long and engaging in frequent acquisitionsc. Random treatment and self-selection treatment in Camerer and Lovallo experimentd. Risk aversion and overconfidence in debt issuance
Investment activity is driven by both rational value-maximization and behavioral influences on the part of managers. Discuss.
In the Camerer and Lovallo experiment, let N=10 and c=2. Specify the number of entrants that maximizes industry profit. What will this industry profit be? Specify the number of entrants that minimizes industry profits. What will this industry profit be? What number of entrants leads to zero
In the Camerer and Lovallo experiment, overconfidence leads to excessive entry into markets. Do you believe that if a prospective entrepreneur read this research she would be more or less likely to undertake a start-up? Explain.
You are a divisional manager. Currently you are a member of a committee which is considering two product investments proposed by two other divisional managers, Joe and John. While walking over to the presentations, Joe seems rather arrogant. He mentions that he golfs with the CEO, is a key
Differentiate the following terms/concepts:a. DCs and DBs b. Auto-enrollment and SDIP programsc. Exponential and hyperbolic discount functionsd. Deferral rate and income replacement rate
Sue is an exponential discounter. Her discount function which illustrates her preference for money at various points in time is characterized as follows: ∂(t)=1/(1.07)t for t=0,1,2,... Bob on the other hand is a hyperbolic discounter. His discount function is: ∂(t) = 1 for t=0 = .8/(1.03)t-1
If employee-investors are unsophisticated and unlikely to be materially influenced by educational efforts, the best way to improve the welfare of employee-investors is pension design. Discuss.
Would you rather have had a DB or a DC in the summer of 2008? Explain.
Differentiate the following terms/concepts:a. Personality types and money attitudes b. Planners and avoidersc. Moderating and adapting to biasesd. "Perfectible judges" and "incorrigible judges"
Say the level of the market as measured by the Dow Jones Industrial Average is currently at 12,000. A forecaster has made a prediction of 13,300 for the level of the market in one year, along with a 95% confidence interval whose lower bound is 12,500 and whose upper bound is 14,500. You know from
What steps must occur before bias can be successfully expunged? Describe the process.
Risk tolerance comes from risk capacity and risk attitude. What are the major determinants of risk capacity and risk attitude?
Describe how educational efforts should be directed towards avoiders.
Differentiate the following terms/concepts:a. Style peer groups and style investingb. Style tilting and style rotationc. Financial soundness and financial statementsd. Univariate and multivariate approaches
Describe how momentum can be refined by conditioning on the entire term structure of interest rates in the manner of the Grinblatt and Moskowitz regression model.
Describe how value investing can be refined by paying close attention to a company's financial statements.
What does the early evidence on the ability of behavioral investing to enhance performance tell us?
Differentiate the following terms/concepts: a. Implicit learning and practice b. Practical knowledge and tacit knowledge c. Expertise and ability d. Brain function and brain part
The fact that uncertainty and risk are experienced differently might matter in times of financial crisis. Discuss.
Emotional balance is desirable for financial traders. Discuss.
Since graduation from college, your friend William has become a highly paid and successful financial advisor. His list of clients is long, and his advice is sought by many. Discuss the merits of the following statement: William's success is primarily driven by luck.
The evidence suggests that the benefit of becoming a skilled financial advisor may far exceed the cost. Discuss why this would be true.
Assume that you have an opportunity to visit a civilization in outer space. Its society is at roughly the same stage of development as the U.S. society is now. Its economic system is virtually identical to that of the United States, but derivative trading is illegal. Compare and contrast this
Contrast dollar return and percentage return. Be sure to identify which return is more useful when comparing investments?
An option dealer needs to finance the purchase of a security and holds an inventory of U.S. Treasury bills. Explain how the dealer can use the repo market for financing the security purchase?
Compare and contrast options and forward contracts?
All derivatives are based on the random performance of something. Identify and discuss this "something"?
What contract would two parties utilize if they agreed to exchange cash flows? How might this transaction proceed? 17?
Assume that you are faced with an opportunity made up of three equally likely outcomes. If the first outcome occurs, you receive $10. If the second outcome occurs, you receive no money. 18. If the third outcome occurs, you must pay out $1. Given that you can be characterized as risk 19. neutral,
If an individual anticipates the price of a stock falling, how would he go about shorting the stock to capture a profit? How does his short position create a liability?
What role do professional codes of ethics play in governing how people manage their financial careers?
What is an efficient market? Why do efficient markets benefit society?
Define arbitrage and the law of one price. What role do they play in the U.S. market system? What do we call the "one price" of an asset?
Suppose you are shopping for a new automobile. You find the same car at two dealers but at different prices. Is the law of one price being violated? Why or why not?
What is storage? Why is it risky? What role does it play in the economy?
What is storage? Why is it risky? What role does it play in the economy? Discuss.
Why is delivery important if so few futures contracts end in delivery?
What are the major functions of derivative markets in an economy?
Why is speculation controversial? How does it differ from gambling?
What are the three ways in which derivatives can be misused?
Consider a call option on an asset with an exercise price of $100, a put option on that same asset with an exercise price of $100, and a forward contract on the asset with an exercise price of $100, all expiring at the same time. Assume that at the expiration, the price of the asset is each of the
What is the difference between bilateral clearing and multilateral clearing?
What is propriety trading?
Why is the bid-ask spread a transaction cost?
How can one make a profit form a transaction in light of the bid-ask spread, assuming the spread remains constant?
What is the difference between an initial margin and a maintenance margin?
Explain the basic differences between open-outcry and electronic trading systems?
Explain the differences among the three means of terminating a futures contract: an offsetting trade, cash settlement, and delivery?
What is the purpose of the ISDA Master Agreement? How does it provide for a means of reducing credit risk?
Suppose you buy a stock index futures contract at the opening price of 452.25 on July 1. The multiplier on the contract is 500, so the price is $500(452.25) = $226,125. You hold the position until selling it on July 16 at the opening price of 435.50. The initial margin requirement is $9,000, and
Give an example of an in-the-money call and put and an out-of-the-money call and put?
The crude oil futures contract on the New York Mercantile Exchange covers 1,000 barrels of crude oil. The contract is quoted in dollars and cents per barrel (e.g., $27.42), and the minimum price change is $0.01. The initial margin requirement is $3,375, and the maintenance margin requirement is
What role does the Basel Committee on Bank Supervision play in derivatives regulation? Why is it not perfectly effective?
Explain the advantages and disadvantages of notional amount compared to market value in measuring OTC derivatives market activity?
How are swaps like combinations of forward contracts?
What is a real option? Why is it important in understanding how companies make decisions?
Which of the following combinations of exchanges is not part of the same entity?a. Chicago Mercantile Exchange and Chicago Board Options Exchangeb. New York Stock Exchange and London International Financial Futures Exchangec. Chicago Board of Trade and New York Mercantile Exchange
What are daily price limits and how are they used by futures exchanges?
Suppose you are an individual investor with an options account at a brokerage firm. You purchase 20 call contracts at a price of $2.25 each on an options exchange. Explain who gets your premium?
Using an example, compare and contrast physical delivery and cash settlement?
Consider an option that expires in 68 days. The bid and ask discounts on the Treasury bill maturing in 67 days are 8.24 and 8.20, respectively. Find the approximate risk-free rate?
Why does the justification for exercising an American call early not hold up when considering an American put?The following option prices were observed for a stock on July 6 of a particular year. Use this information to solve problems 11 through 16. Unless otherwise indicated, ignore dividends on
Compute the intrinsic values, time values, and lower bounds of the following calls. Identify any profit opportunities that may exist. Treat these as American options for purposes of determining the intrinsic values and time values and European options for the purpose of determining the lower
Compute the intrinsic values, time values, and lower bounds of the following puts. Identify any profit opportunities that may exist. Treat these as American options for purposes of determining the intrinsic values and time values and European options for the purpose of determining the lower
Check the following combinations of puts and calls and determine whether they conform to the put-call parity rule for European options. If you see any violations, suggest a strategy? a. July 155 b. August 160 c. October 170
Repeat problem 13 using American put-call parity, but do not suggest a strategy?
Examine the following pairs of calls, which differ only by exercise price. Determine whether either of them violates the rules regarding relationships between American options that differ only by exercise price?a. August 155 and 160b. October 160 and 165
Examine the following pairs of puts, which differ only by exercise price. Determine whether either of them violates the rules regarding relationships between American options that differ only by exercise price?a. August 155 and 160b. October 160 and 170
On December 9 of a particular year, a January Swiss franc call option with an exercise price of 46 had a price of 1.63.The January 46 put was at 0.14. The spot rate was 47.28. All prices are in cents per Swiss franc.The option expired on January 13. The U.S. risk-free rate was 7.1 percent, and the
Suppose the current stock price is $100, the exercise price is $100, the annually compounded interest rate is 5 percent, the stock pays a $1 dividend in the next instant, and the quoted call price is $3.50 for a one-year option. Identify the appropriate arbitrage opportunity and show the
Suppose the current stock price is $90, the exercise price is $100, the annually compounded interest rate is 5 percent, the stock pays a $1 dividend in the next instant, and the quoted put price is $6 for a one-year option. Identify the appropriate arbitrage opportunity and show the appropriate
What would happen in the options market if the price of an American call were less than the value Max(0, S0 - X)? Would your answer differ if the option were European? Explain.
Suppose the annually compounded risk-free rate is 5 percent for all maturities. A non-dividend-paying common stock is trading at $100. Suppose you are considering a European call option with a strike price of $110. What is the time to maturity of this option where the boundary condition begins to
A non-dividend-paying common stock is trading at $100. Suppose you are considering a European put option with a strike price of $110 and one year to expiration. What is the annually compounded risk-free interest rate where the boundary condition begins to be nonzero?
Suppose a European put has an exercise price of $110 on February 5. The put expires in 45 days. Suppose the appropriate discount rate on Treasury bills maturing in 44 days is 7.615. What is the maximum value of the European put? If the put were instead an American put, what would be its maximum
Suppose an American put is trading for $16.50 and an American call is trading for $15, where both options have identical terms. The underlying stock price is $99, and the exercise price is $100. The annual risk-free interest rate is 5 percent, and the time to expiration for both options is one
Suppose you observe options on Apple, Inc. stock trading such that the following condition is observed:S0 + Pa(S0,T,X) < Ca(S0,T,X) + X(l + r)"1'.Explain how an arbitrageur would seek to capitalize on this observation and defend your answer?
Consider a call option on the U.S. dollar written in Indian rupees (₹). The current spot exchange rate is ₹ 70/$, the Indian interest rate is 7 percent, and the U.S. interest rate is 5 percent (both annual compounding). If you observe a one-year at-the-money call option trading for ₹ 1.2/$,
(Concept Problem) Put-call parity is a powerful formula that can be used to create equivalent combinations of options, risk-free bonds, and stock. Suppose there are options available on the number of points LeBron James will score in his next game. For example, a call option with an exercise price
(Concept Question) Suppose Congress decides that investors should not profit when stock prices go down, so it outlaws short selling. Congress has not figured out options, however, so there are no restrictions on option trading. Explain how to accomplish the equivalent of a short sale by using
Suppose you observe a European call option that is priced at less than the value Max[0, S0 - X(l + r)-T]. What type of transaction should you execute to achieve the maximum benefit? Demonstrate that your strategy is correct by constructing a payoff table showing the outcomes of expiration.
Explain why an option's time value is greatest when the stock price is near the exercise price and why it nearly disappears when the option is deep-in- or out-of-the-money?
Critique the following statement made by an options investor: "My call option is very deep-in-the-money. I don't see how it can go any higher. I think I should exercise it?"
Call prices are directly related to the stock's volatility, yet higher volatility means that the stock price can go lower. How would you resolve this apparent paradox?
The value Max [0, X (l + r)"T - S0] was shown to be the lowest possible value of a European put. Why is this value irrelevant for an American put?
Why do higher interest rates lead to higher call option prices but lower put option prices?
Suppose a European put price exceeds the value predicted by put-call parity. How could an investor profit? Demonstrate that your strategy is correct by constructing a payoff table showing the outcomes at expiration.
Why are the probabilities of stock price movements not used in the model for calculating an option's price? What variables are used?
Find the value of an American put option using the binomial option pricing model. The parameters are S = 62, X = 70, r = 0.08, u = 1.10, and d = 0.95. There are no dividends. Use n = 2 periods?
Consider a European call with an exercise price of 50 on a stock priced at 60. The stock can go up by 15 percent or down by 20 percent in each of two binomial periods. The risk-free rate is 10 percent. Determine the price of the option today. Then construct a risk-free hedge of long stock and short
Construct a table containing the up and down factors for a one-year option with a stock volatility of 55 percent and a risk-free rate of 7 percent for n = 1, 5, 10, 50, and 100, where n is the number of binomial periods. Let u and d be defined as u = e( (T/nd = 1/u.

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Introduction To Derivatives And Risk Management 10th Edition Don M. Chance, Robert Brooks - Solutions

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