A dealer buys a 2-year put option on the S&P500 index from its counterparty. The Black-Scholes...
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A dealer buys a 2-year put option on the S&P500 index from its counterparty. The Black-Scholes value of the option, assuming no possibility of default, is $4. Suppose the 2-year zero-coupon bond issued by the counterparty has a yield that is 100 basis points higher than the 2-year risk free zero-coupon bond. 1) How much should the dealer be prepared to pay for the option? [3 marks] 2) Explain why wrong-way risk can be expected to be observed in this example. [4 marks] 3) How do Basel rules deal with wrong-way risk? [3 marks] A dealer buys a 2-year put option on the S&P500 index from its counterparty. The Black-Scholes value of the option, assuming no possibility of default, is $4. Suppose the 2-year zero-coupon bond issued by the counterparty has a yield that is 100 basis points higher than the 2-year risk free zero-coupon bond. 1) How much should the dealer be prepared to pay for the option? [3 marks] 2) Explain why wrong-way risk can be expected to be observed in this example. [4 marks] 3) How do Basel rules deal with wrong-way risk? [3 marks]
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Related Book For
Intermediate Accounting IFRS
ISBN: 978-1119372936
3rd edition
Authors: Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield
Posted Date:
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