ECON2151-WE01

Financial Markets and Institutions

2023

1.

(i)        Demonstrate how a bear and a bull spread are created using options and explain the circumstances under which a trader might construct each spread.

(ii)       Use a numerical example to evaluate the potential payoffs and profits from a strip and a strap combination.

2.

(i)       A forward contract with 8 months to maturity is written on an underlying share. The

market price of the share is $34, and it is expected to pay dividends of $1.40 after 2 months and $2 immediately prior to maturity of the forward. The relevant riskless rate of interest is 4%. Calculate the theoretical forward price and initial value of the forward contract and explain the forward pricing relationship. (60 marks)

(ii)         Provide a numerical example of an arbitrage strategy for situations where the forward is trading above, and below the theoretical forward price. (40 marks)

3.

(i)        Identify the key parameters that influence option price. Discuss the impact of a rise

and fall in the value of each parameter on the prices of put and call options.  (60 marks)

(ii)      An option holder has long positions in call and put options written on an underlying asset currently priced at €50. Numerically demonstrate the intrinsic values and moneyness ranges for the options using a range of plausible exercise (strike) prices and premiums. (40 marks)

4.

(i)      Demonstrate, using a numerical example, how a portfolio of stocks can be hedged using stock index futures. (40 marks)

(iii)      Explain and critically evaluate the classic, beta and minimum variance hedge ratios. (60 marks)

5.

(i)       Explain and discuss the process of securitisation.

(ii)       Explain how credit default swaps are constructed and discuss their application in hedging and speculation.

6.

Demonstrate how interest rate and currency swaps are constructed and discuss the comparative advantage argument used to illustrate the popularity of swaps.