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Ollscoil na hÉireann, Gaillimh GX_____
National University of Ireland, Galway
Semester II Examinations 20 10
Exam Code(s) 1MIF Exam(s) M.Econ.Sc. in International Finance Module Code(s) EC Module(s) SEMINAR IN FINANCIAL ECONOMICS II Paper No. 1 Repeat Paper Special Paper External Examiner(s) Prof. C. Ryan Internal Examiner(s) Prof. J. McHale C. Twomey Instructions: EC568 Students Answer 3 questions in Section A ( 33 marks each) Answer 1 question in Section B ( 33 marks each) If you attempt MORE THAN the correct number indicate clearly those questions which you wish to be graded. The use of calculators is permitted - programmable calculators may not be used. Duration 3 hrs No. of Answer Books 1 Requirements : Statistical Tables - Yes Department(s) Economics
Answer 3 Questions – All questions are worth the same marks
(a) A stock option contract can be characterised as a zero-sum game between the buyer and the seller about the short-term price moves in the underlying equity. Explain. ( 9 marks) (b) Holding all else equal, indicate how each of the following unexpected events will increase, decrease, or have no effect on the time value and/or minimum expiration value of a given outstanding call option: (i) decrease in the underlying share’s dividend, (ii) decrease in the underlying share's volatility, (iii) decline in the underlying share's price. (9 marks) (c) Take the following options data from the Financial Times on 11th^ February, 2011. CALLS PUTS Option Feb Mar Apr Feb Mar Apr Lloyds Bank 64 2.5 4 5 0.75 2.5 3. (65.80) 68 0.75 2 3 2.75 4.25 5. Man Group 300 10 16.25 20.25 2.75 8.25 11. (307.40) 310 4.5 10.75 14.75 7.25 13 16. M & S 370 6.25 13.25 18 5 11.5 15. (*371.60) 380 2.5 9.25 13.25 11 17.25 21. i. An investor wishes to use Man Group Mar call options to construct a bear spread. Under what circumstances would an investor wish to use a bear spread? Using a payoff matrix and a diagram, illustrate the net profit or loss to the investor from this strategy at maturity. ii. When would it be appropriate for an investor to use a strangle? Suppose you wish to create a strangle for Lloyds Bank using Apr options. Using a payoff matrix and a diagram, illustrate the net profit or loss to the investor from this strategy at maturity. (15 marks)
2. Over the past 25 years there have been a number of high-profile derivatives related losses. For any two cases with which you are familiar: (i) Compare and contrast the trading strategies or actions primarily responsible for the losses in each case and (ii) Discuss the main lessons that you believe should be learned from the cases in question. (33 marks)
SECTION B
Please Answer 1 Question Each Question is worth 33 marks NB: This section is for MSc. in International Finance students only 1. (a) Write out the key formulas for the Black-Scholes-Merton option-pricing model. Explain clearly the logic underpinning the formula. (8 marks) (b) Using the Black-Scholes-Merton option-valuation formula, compute the price of a Microsoft (MSFT) call option with 4 months to expiration that has a strike price of $26. Assume the current stock price is $27, the US Treasury-bill yield is 1.5%, and the volatility of MSFT is 18 %. ( 10 marks) (c) Write out the formula for put-call parity. Then, using the information provided in Part (b) above, use the put-call parity concept to compute the value of a Microsoft put option with the same strike price and time to expiration. (6 marks) (d) Outline briefly how an investor could trade based on an option’s implied volatility. ( 9 marks) 2. (a) Using conventional options notation, outline and write the payoffs for any three common real options ‘embedded’ in corporate investment projects. (12 marks) (b) “To factor real-world uncertainties into your decisions, look beyond net-present value…recognising that an investment opportunity is like a financial option clarifies the role of uncertainty,” Dixit, A. and R. Pindyck, ‘The Options Approach to Capital Investment,’ Harvard Business Review May-June 1995, p. 86. In your opinion, do real options have the potential to be an important tool for non- financial firms? Use examples where appropriate. (21 marks)
