Drillmaster Sdn Bhd has developed a powerful new hand drill that would be used for woodwork and carpentry activities. It would cost $1 million to buy the equipment necessary to manufacture the drills, and it would require net operating working capital equal to 10% of sales. It would take 1 year to buy the required equipment and set up operations, and the project would have a life of 5 years. If the project is undertaken, it must be continued for the entire 5 years. The firm believes it could sell 1,000 units per year. The drills would sell for $240 per unit, and Webmasters believes that variable costs would amount to $175 per unit. The company's nonvariable costs would be $100,000 at Year 1 and would increase with inflation. After the first year the sales price and variable costs will increase at the inflation rate of 3%. The equipment would be depreciated over a 5-year period, using the straight-line method. The estimated market value of the equipment at the end of the project's 5-year life is $100,000. The tax rate is 25%.

Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. Its cost of capital is 10% for average-risk projects, defined as projects with a coefficient of variation of NPV between 0.8 and 1.2. Low-risk projects are evaluated with a WACC of 8%, and high-risk projects at 13%.

a. Develop a spreadsheet model and use it to find the project's NPV, IRR, and payback

A public utility has a relatively low credit (BBB) rating. It would like to match its long-term assets with long-term, fixed-rate debt, but it finds long-term, fixed-rate funding expensive. An oil company has a higher (AA) credit rating. It can issue fixed-rate debt at a low cost but prefers to issue short-term commercial paper to fund its credit card receivables.

The Treasurers of the two companies know one another and agree to do the swap without using a bank as an intermediary.

The public utility (BBB) can borrow in the bond market at 6.5% and can obtain a floating-rate loan from its bank that reprices annually at SOFR+0.50%. (SOFR is the Secured Overnight Financing Rate - the new benchmark interest rate for dollar-based lending.) The oil company (AA) can issue bonds at 4.85% or issue A1/P1-rated commercial paper at 5 basis points below SOFOR (at SOFR - 0.05%).

a) Set up a possible swap between these two firms. Show the potential gains, if any, to each party from the swap.

b) What are the risks, if any, to each party to this swap?

Suppose you think a company's stock is going to appreciate substantially in value next year. The stock's current price, S0, is $60 and the call option expiring in one year has an exercise price of $60 and a call on this stock is selling at a price of $6. With $60,000 to invest, you are considering three alternatives:

a. Invest all $60,000 in the stock

b. Invest all $60 000 in options

c. Buy 5,000 options and invest the balance in a money market fund paying 5% interest annually.

Using the above information answer the following questions:

Calculate the rate of return for each alternative for four stock prices ($50, $60, $70,$80) one year from now? Summarize your results in a table. Draw a graph showing the rate of return for each alternative

Part b.

The following data relate to a listed company.

Current share price = $160

Exercise price = $190

Maturity = 6 months

Risk free rate of return = 5% per annum

Dividend yield = 3% per annum

Standard deviation of share returns =40%

Using the above data, estimate the value of a call option Using the calculated call option price and other relevant data, estimate the price of a put option using the put-call parity relationship. If the market value of the put option is $1 less than the value of the put option estimated in ii above, explain if there are any arbitrage opportunities. If there are arbitrage opportunities, explain the strategy you would follow to profit from it.

Happy Jalapenos, LLC has an exclusive contract to supply jalapeno peppers to the organizers of the annual jalapeno eating contest. The contract states that the contest organizers will take delivery of 10,000 jalapenos in one year at the market price. It will cost Happy Jalapenos 1,000 to provide 10,000 jalapenos and today's market price is 0.12 for one jalapeno. The continuously compounded risk-free interest rate is 6%. Happy Jalapenos has decided to hedge as follows: Buy 10,000 0.12-strike put options for 84.30 and sell 10,000 0.14-stike call options for 74.80. Both options are one-year European. Happy Jalapenos believes the market price in one year will be somewhere between 0.10 and 0.15 per jalapeno. Determine which of the following intervals represents the range of possible profit one year from now for Happy Jalapenos. (A) -200 to 100 (B) -110 to 190 (C) -100 to 200 (D) 190 to 390 (E) 200 to 400 4 5. The PS index has the following characteristics: One share of the PS index currently sells for 1,000. The PS index does not pay dividends. Sam wants to lock in the ability to buy this index in one year for a price of 1,025. He can do this by buying or selling European put and call options with a strike price of 1,025. The annual effective risk-free interest rate is 5%. Determine which of the following gives the hedging strategy that will achieve Sam's objective and also gives the cost today of establishing this position. (A) Buy the put and sell the call, receive 23.81 (B) Buy the put and sell the call, spend 23.81 (C) Buy the put and sell the call, no cost (D) Buy the call and sell the put, receive 23.81 (E) Buy the call and sell the put, spend 23.81 6. The following relates to one share of XYZ stock: The current price is 100. The forward price for delivery in one year is 105. P is the expected price in one year Determine which of the following statements about P is TRUE.

55. Which of the following is a strategy for linking performance measures to financial outcomes: A. Analyzing click-through rates B. Developing advertising budgets C. Paying for direct-mail pieces D. Maintaining sales receipts 56. What type of software do many businesses require be installed on computer systems as a security feature? A. Reality B. Firewall C. Spider D. Media 57. The FPD Company keeps copies of its brochures, catalogs, and flyers on file for future reference. This is an example of a company that is maintaining __ records. A. inventory B. legal C. promotional D. asset 58. Which of the following is most likely to be a dynamic element of a business's external environment: A. Decrease in personnel B. Increase in competition C. Renewed emphasis on training D. New quality control measures 59. James needs to hire a bookkeeper for his growing business. To determine the new employee's salary, James obtained pay data from five companies in his industry that are similar in size. The research indicated the following: Company A pays $31,205; Company B pays $29,995; Company C pays $34,800; Company D pays $42,500; and Company E pays $36,500. James decided to set his bookkeeper's salary at $35,000. What measure of central tendency did James use to set his new employee's salary? A. Mode B. Mean C. Range D. Median 60. Hill Industries uses specific criteria to evaluate vendor performance, including on-time delivery rate, return rate, and number of customer complaints. These metrics are also known as A. consensus scales. B. performance indicators. C. economic indicators. D. return on capital. 61. A business converts inputs into outputs through its__ activities. A. accounting B. management C. marketing D. production

Alpha Seekers is currently operating in the US and specialises in managing equity portfolios for different institutional clients. It relies heavily on using derivative contracts for managing the risks around the equity investments for the portfolios it manages for different institutional investors. As a junior analyst on the derivatives trading desk, the task is to support the line manager at Alpha Seekers in reporting and presenting it before the management of Teachers Pension Fund, one of its new institutional clients.

Question 1

Teachers Pension Fund has indicated interest in international investments in equity securities and has requested Alpha Seekers to consider the UK equity market. Alpha Seekers has indicated that such a portfolio would also require the use of different derivative contracts to manage risk and that generally it prefers to use exchange-traded derivatives to over the counter (OTC) contracts. Further Alpha Seekers identified Intercontinental Exchange (ICE) and Eurex Exchange as the two potential organised trading markets to consider for trading derivative contracts for managing risk of Teachers Pension Fund's potential investment portfolio.

A) Identify the features of futures on BT Group listed on ICE and Eurex Exchange. Compare the differences between ICE and Eurex options on BT Group.

B) Assess futures and options listed on both ICE and Eurex markets and the features of available derivative contracts on BT Group & recommend which market should be used for trading.

As a junior analyst, you have been tasked by your line manager to prepare supporting calculations in your report for a presentation to be made before Teachers Pension Fund's management. These calculations should essentially demonstrate derivative pricing using the No Arbitrage Principle. To do so, you choose to demonstrate the pricing of futures and options contract on BT Group listed on Eurex Exchange. The line manager also wants to understand more about risk neutral pricing and expects you to provide some explanation of the underlying concepts

A) Estimate the fair price of any BT Group futures contract on Eurex using the cost of carry model. You are required to cover the following too:

provide (select and make assumptions) any missing inputs. explain all the inputs in your pricing model and justify each. compare the price from your cost of carry model against the actual price at the day close and explain any underlying reasons for the under-pricing or over-pricing.

B) i). Estimate the prices of both a BT Group call and a BT Group put option trading on Eurex Exchange using two and three period binomial option pricing models as well as the BSM model. You must cover the following:

provide (select and make assumptions) any missing inputs. explain all the inputs in your pricing model and justify each. evaluate whether the call and the put options are over or under-valued based on the price estimates from your calculations compared to their actual prices on Eurex Exchange.

ii). For the two period binomial model, demonstrate that the estimated price of the call is fair using the hedge portfolio calculations over the two period and adjusting the hedge ratio accordingly.

C) Estimate the value of the risk free bonds from the put-call parity using first the prices of calls and puts from the BSM model in B above and then the actual prices of calls and puts available from Eurex Exchange for the same calls and puts. Discuss the factors that could explain the differences in pricing across the two put-call parity calculations.

D) Explain Risk Neutral behaviour and describe how it is different than Risk Averse and Risk Seeking behaviours in financial markets. Give relevant examples of each from financial markets. Why is derivatives pricing considered to be risk neutral? Explain.

Though Alpha Seekers Investments has a general preference for exchange-traded derivatives, the management of Teachers Pension Fund is interested in knowing more about the use of OTC derivatives particularly forwards and Swaps for managing the risks of their proposed investments in UK equities. Your line manager requires your report to cover this too.

A) Explain the mechanics of a Basis Spread with numerical example. B) Illustrate the pricing of a hypothetical forward contract on BT Group's stock and how it can be used to manage the risk of the proposed investment. You will have to consider and choose the required inputs and make reasonable assumptions wherever required. Provide clear descriptions of all the steps in the process and a conclusion.

C) Illustrate the pricing of a hypothetical swap contract involving Teachers Pension Fund receiving Fixed GBP Rate derived from GBP Libor[1] rate and paying the returns on BT Group's stock; assume an investment of 2,500,000, payments made quarterly for one year. For any missing Libor term rates, assume that the term structure of interest rates is linear and upward sloping. Provide detail descriptions of each step.

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