1. Explain what options exist in a convertible-callable corporate bond.
2. If you hold a callable bond and the volatility of interest rates increase, what do you think usually happens to the value of your bond?
3. If you hold a convertible bond and the volatility of equity prices declines, what is the effect on bond value, assuming nothing else changes?
4. A Quanto (quantity) option is one in which the option contains price risk from two sources. Quantos are discussed in Chapter 18 on path-indendepent exotic options. An example is where you buy a put option on the Nikkei stock index (which is yen-denominated), but the strike price of the option is stated in dollars. Explain what the di aren’t sources of risk in such an option might be. For each source of risk, state in which direction it must move for the value of the option to increase.
5. A European investor in the US equity markets wants to buy a Quanto call on the S&P 500 index, where the strike is written in euros. (See the previous question for the de nition of a quanto). Can you explain why the investor wants such an option? Also, explain what risks the investor is hedging by buying a quanto call on the equity index rather than a plain call on the S&P 500.
5. If you are manufacturing consumer products that use oil-based chemicals as inputs, then you are subject to oil price risk. Suppose you order your oil from Saudi Arabia and usually pay for it in Saudi rials. You are now concerned that the appreciation in the rial will an ect your pro stability.
(a) How would you use forward contracts to hedge the risk of your oil purchases?
(b) What type of quanto option would you like to buy to hedge this risk? (See Question 18 for the de nition of a quanto.)
6. Employee stock options have additional risk over and above standard call options in that the employee may not be able (or allowed) to cash in the option in the event of termination of the employee’s job with the rm if the option is not vested. But if the Sundaram & Das: Derivatives – Problems and Solutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 option is vested, and immediate exercise in the event of termination is possible, should it be worth as much as a standard American option on the rm’s stock price? Explain.
7. Market timers are traders who vary their allocation between equity and bonds so as to optimize the performance of their portfolios by trading o one market versus the other. Rather than physically trade in the two markets, you want to avail yourself of the best return from the bond or stock markets over the next year using an option. Suggest an option that will provide you this result. (Feel free to dene the option’s terms.) What factors drive the value of this option? Get Finance Help Today
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