The following questions are based on derivative investments. The table below shows the spot and forwards...

  

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The following questions are based on derivative investments. The table below shows the spot and forwards of 6M LIBOR and 12M LIBOR. [Total: 25] 6M LIBOR 12M LIBOR Spot market 100 5.0% 5.0% (a) Evaluate the forward rates that are missing in the Table. [4] (b) Based on the 12M LIBOR spot rate, show that the 1-year continuously com- pounded rate ry equals 4.879%. [4] Use the risk-free rate ry from (b) to answer the following questions. (c) The derivative team uses the binomial tree below to evaluate the 1-year American PUT option of a non-dividend stock. Determine the probability p. If the strike price is £100, find the nodes of early execution. [10] p=? 110 1-p 90 121 Forward market 99 6-month 12-month 18-month maturity maturity maturity ??? 6.0% ??? ??? 4.0% 6.0% 81 133.1 108.9 89.1 72.9 146.41 119.79 98.01 80.19 65.61 (d) A binary option is a financial exotic option. A 1-year binary option will be automatically exercised and the long side gets £1 if the spot price at maturity is higher than the strike price £100. Evaluate the binary option price using the binomial tree from part (c). [7] The following questions are based on derivative investments. The table below shows the spot and forwards of 6M LIBOR and 12M LIBOR. [Total: 25] 6M LIBOR 12M LIBOR Spot market 100 5.0% 5.0% (a) Evaluate the forward rates that are missing in the Table. [4] (b) Based on the 12M LIBOR spot rate, show that the 1-year continuously com- pounded rate ry equals 4.879%. [4] Use the risk-free rate ry from (b) to answer the following questions. (c) The derivative team uses the binomial tree below to evaluate the 1-year American PUT option of a non-dividend stock. Determine the probability p. If the strike price is £100, find the nodes of early execution. [10] p=? 110 1-p 90 121 Forward market 99 6-month 12-month 18-month maturity maturity maturity ??? 6.0% ??? ??? 4.0% 6.0% 81 133.1 108.9 89.1 72.9 146.41 119.79 98.01 80.19 65.61 (d) A binary option is a financial exotic option. A 1-year binary option will be automatically exercised and the long side gets £1 if the spot price at maturity is higher than the strike price £100. Evaluate the binary option price using the binomial tree from part (c). [7]

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a Evaluate the forward rates that are missing in the Table The missing forward rate for 6month matur... View the full answer