Problem 3: Derivatives Valuation

A stock price is currently $36. During each three-month period for the next six months it is expected to increase by 9% or decrease by 8%. The risk-free interest rate is 5%. Use a two-step tree to calculate the value of a derivative that pays off (max[(40-S_T),0])² where St is the stock price in six months.

1. What are the payoffs at the final nodes of the tree? [1 mark]
2. Use no-arbitrage arguments (you need to show how to set up the riskless portfolios at the different nodes of the binomial tree). [2 mark]
3. Use risk-neutral valuation. [1 mark]
4. Verify whether both approaches lead to the same result. [1 mark]
5. If the derivative is of American style (S_T in the payoff function refers to the stock price when the option is exercised), should it be exercised early? [1 mark]

Problem 3: Derivatives Valuation A stock price is currently $36. During each three-month period for the next six months it is expected to increase by 9% or decrease by 8%. The risk-free interest rate is 5%. Use a two-step tree to calculate the value of a derivative that pays off (max[(40-ST),0])2 where ST is the stock price in six months.

a. What are the payoffs at the final nodes of the tree?

b. Use no-arbitrage arguments (you need to show how to set up the riskless portfolios at the different nodes of the binomial tree).

c. Use risk-neutral valuation.

d. Verify whether both approaches lead to the same result.

e. If the derivative is of American style (ST in the payoff function refers to the stock price when the option is exercised), should it be exercised early?

Problem 3: Derivatives Valuation A stock price is currently $36. During each three-month period for the next six months it is expected to increase by 9% or decrease by 8%. The risk-free interest rate is 5%. Use a two-step tree to calculate the value of a derivative that pays off (max[(40-ST),0])2 where ST is the stock price in six months.

a. What are the payoffs at the final nodes of the tree? - not PV's for prices on tree

b. Use no-arbitrage arguments (you need to show how to set up the riskless portfolios at the different nodes of the binomial tree).

c. Use risk-neutral valuation. d. Verify whether both approaches lead to the same result. e. If the derivative is of American style (ST in the payoff function refers to the stock price when the option is exercised), should it be exercised early?

Who wrote “A little rebellion now and then is a good thing. The tree of liberty must be refreshed from time to time with the blood of patriots and tyrants”

a.Patrick Henry

b.Edmund Burke

c.Samuel Adams

d.Thomas Jefferson

e.James Madison

The first government document to be considered an “operating manual” for the new United States following the conclusion of the American Revolution was

a. Articles of Confederation

b.The Constitution

c.The Declaration of Independence

d.Naturalization Act of 1790

e.Bill of Rights

Of most following documents or philosophies, which is most associated with the concept of “Division of Powers”:

a.Articles of Confederation

b.Federalism

c.The Declaration of Independence

d.Naturalization Act of 1790

e.Bill of Rights

Which of the following documents from the early years of the United States

stated that citizenship was limited to whites only

a.Articles of Confederation

b.The Constitution

c.The Declaration of Independence

d.Naturalization Act of 1790

e.Bill of Rights

According to Benjamin Franklin’s pamphlet “Information to Those Who Would

Remove to America,” who is “needed” in America, and who would be better

served staying in Europe? What reasons does he provide for his views? If

Franklin were around today, what might he include in his pamphlet?

Consider the balance sheets of two banks: Wells America and Bank of Fargo. Assume that the legal reserve requirement is 10 percent of all deposits. A. Suppose that Wells America has $200 billion in checkable deposits, $30 billion in reserves, $60 billion in securities, and $150 billion in loans. Draw a balance sheet (T-account) for Wells America. What is the dollar value of its bank capital? How much does Wells America hold in excess reserves? How is this related to liquidity risk? Explain. Assume that Bank of Fargo has the following balance sheet information: $240 billion in checkable deposits, $166 billion in loans, $10 billion in bank capital, and no excess reserves. Show the balance sheet for Bank of Fargo. What are the dollar values of its reserves and securities? What is the leverage ratio for each bank? Which bank is more likely to become insolvent in the event of a large decrease in the dollar value of its securities? Explain.

6 questions below.

1) The CFO is concerned with a mix of what two factors when managing the capital structure?

A

Borrowing

B

Ownership financing

C

Accounts payable

D

Fixed asset purchases

2)

Name an example of an agency conflict found within an organization.

3)

What operations or actions can't a financial manager or employee do to maximize shareholder wealth?

4.)

Of the following, which questions will be discussed by a financial manager when performing the capital budgeting process?

A

Should we invest in a new piece of equipment?

B

Should I hire Tony as a data analyst?

C

Should we buy a competing firm?

5.)

Which question(s) below will a financial manager consider when performing working capital management processes?

A

How much inventory should I keep on hand this quarter?

B

How will the Christmas season impact my carrying costs?

C

How much credit should I extend to my customers?

6.)

What are examples of long-term investments for organizations?

A

Acquisition of a competitor.

B

Purchase of a new piece of machinery.

C

Open up a subsidiary in South America.

D

Develop a new line of products.

Recognizing Accounts Receivable On June 7, Bixby Co. sells $1,250 of merchandise to Jasmine Co. on account. Jasmine Co. pays for this merchandise on June 21. Prepare the entry on Bixby's books to record the sale. Prepare the entry on Bixby's books to record the receipt of payment. a. General Journal Date Description Debit Credit June 7 Answer Answer Answer Answer Answer Answer To record sales of merchandise. b. General Journal Date Description Debit Credit June 21 Answer Answer Answer Answer Answer Answer To record receipt of cash from customer. Question 2Not yet answeredMarked out of 5.00 Not flaggedFlag question Question text Maturity Dates of Notes Receivable Determine the maturity date and compute the interest for each of the following notes: (Use 360 days for interest calculation. Round to the nearest dollar.) Date of Note Principal Interest Rate Term a. August 5 $12,000 8% 45 days b. May 10 33,600 7% 75 days c. October 20 48,000 9% 120 days d. July 06 9,000 10% 45 days e. September 15 18,000 8% 90 days Maturity Date Month Day Interest a. Answer Answer Answer b. Answer Answer Answer c. Answer Answer Answer d. Answer Answer Answer e. Answer Answer