Question:
You must show calculation detail in Excel Format (with formulas posted in Excel Cells) to earn credit for homework assignments. I am also posting the final check numbers for all calculation Problems.
Showing calculation detail in Excel Format (with formulas posted in Excel Cells) is a must for earning any credit for homework assignments. As an alternative to an Excel Spreadsheet, you can and should also use the Worksheets provided for some of the problems in Doc Sharing.
These Worksheets will save you a lot of time.
Please Note: Do not post a narrative of the calculation detail, instead you must post the calculation formulas in the Excel cells.
Problem 1 on Return on Options
Consider the September 2012 IBM call and put options in Problem 20-3. Ignoring any interest you might earn over the remaining few days' life of the options, consider the following.
a) Compute the break-even IBM stock price for each option (i.e., the stock price at which your total profit from buying and then exercising the option would be 0).
b) Which call option is most likely to have a return of -100%?
c) If IBM's stock price is $216 on the expiration day, which option will have the highest return?
Problem 2 on Option Valuation Using the Black Scholes Model
Rebecca is interested in purchasing a European call on a hot new stock-Up, Inc. The call has a strike price of $100 and expires in 90 days. The current price of Up stock is $120, and the stock has a standard deviation of 40% per year. The risk-free interest rate is 6.18% per year.
a) Using the Black-Scholes formula, compute the price of the call.
b) Use put-call parity to compute the price of the put with the same strike and expiration date.
Problem 3 on Swaps Based
Your firm needs to raise $100 million in funds. You can borrow short-term at a spread of 1% over LIBOR. Alternatively, you can issue 10-year, fixed-rate bonds at a spread of 2.50% over 10-year treasuries, which currently yield 7.60%. Current 10-year interest rate swaps are quoted at LIBOR versus the 8% fixed rate.
Management believes that the firm is currently underrated and that its credit rating is likely to improve in the next year or two. Nevertheless, the managers are not comfortable with the interest rate risk associated with using short-term debt.
a) Suggest a strategy for borrowing the $100 million. What is your effective borrowing rate?
b) Suppose the firm's credit rating does improve 3 years later. It can now borrow at a spread of 0.50% over treasuries, which now yield 9.10% for a 7-year maturity. Also, 7-year interest rate swaps are quoted at LIBOR versus 9.50%. How would you lock in your new credit quality for the next 7 years? What is your effective borrowing rate now?