General concepts

manish.g
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Posts: 10
Joined: Sun May 06, 2012 2:31 pm

General concepts

Postby manish.g » Mon May 14, 2012 9:14 pm

Hi,

Can you please help me understand the concept for below ques:


Ques 1 -->Suppose there are two call options on the same stock which is trading at $40. The options are having strike prices of $40 (C40) and $45(C45). Suppose the volatility of the stock increases by 0.001. How will be the increase in the values of the two call options?
Choose one answer.
a. Value of C_40 will increase more than the increase in the value of C_45.
b. Value of C_40 will increase less than the increase in the value of C_45.
c. Value of C_40 will increase by the same amount as the increase in the value of C_45.
d. It cannot be determined whose value will increase more.

.The correct answer is Value of C40 will increase by the same amount as the increase in the value of C45.
Vega is maximum at the money.

Isnt C_40 will be more senstitive than C_45 ???



Ques 2 -->The current price of one share of XYZ stock is 100. The forward price for delivery of one share of XYZ stock in one year is 105. Which of the following statements about the expected price of one share of XYZ stock in one year is TRUE?
Choose one answer.
a. It will be less than 100
b. It will be equal to 100
c. It will be greater than 105
d. It will be equal to 105
.The correct answer is It will be greater than 105
In general, an investor should be compensated for time and risk. A forward contract has no investment, so the extra 5 represents the risk premium. Those who buy the stock expect to earn both the risk premium and the time value of their purchase and thus the expected stock value is greater than 100 + 5 = 105.


Isnt the value be 105 for no arbitrage ???


Ques 3 --> A 3-year bond with a face value $100 has a LIBOR + 80 basis points semi-annual coupon. LIBOR is 6% for all maturities. The discount factor is 0.0345. Determine the bond price.
Choose one answer. a. $99.41
b. $100.59
c. $101.41
d. $101.59
.The correct answer is $99.4
Yield > coupon, hence price < face value.

How the yield calculated here ???


Ques 4 --> Shares of a company are trading at $40. The probability of an upward movement of $5 in a month is 60% and that of downward movement of $5 in a month is 40%. Determine the mean and standard deviation of the stock price assuming that the prices are not affected by the rise or fall in the previous month.
Choose one answer.
a. 48 and 6.93
b. 42 and 6.48
c. 42 and 6.93
d. 42 and 8
.The correct answer is 42 and 6.93
Developing a two step tree. Mean = 0.36(50) + 0.48(40) + 0.16(30) = 42. Variance = 0.36(50 – 42)2 + 0.48(40 – 42)2 + 0.16(30 – 42)2 = 48, hence standard dev = 6.93


Why 2 step tree as it is not mentioned in the ques ???

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jaspreet.frm
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Posts: 13
Joined: Mon May 14, 2012 2:42 pm

Re: General concepts

Postby jaspreet.frm » Tue May 15, 2012 3:28 pm

Question 2 : Forward Contracts are established so that their initial value is zero. This is achieved by setting the forward price F by no-arbitrage relationship between the cash and forward markets.
But in between or at the end of the contract the stock price can be greater than no-arbitrage forward price based on the risk premium and time value of money

jaspreet.frm
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Posts: 13
Joined: Mon May 14, 2012 2:42 pm

Re: General concepts

Postby jaspreet.frm » Tue May 15, 2012 3:32 pm

Question 1:
As per the concept of vega, The at-the-money option will always have the greatest vega. In this question C_40 has more vega than C_45. So, the value of C_40 will change more than C_45 with same change in volatility.
Could you please tell me the source of your question.

manish.g
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Posts: 10
Joined: Sun May 06, 2012 2:31 pm

Re: General concepts

Postby manish.g » Tue May 15, 2012 4:03 pm

source for tht ques is

"6 November 2011-Mock Test III: Afternoon Session" posted on edupristing quiz section

jaspreet.frm
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Posts: 13
Joined: Mon May 14, 2012 2:42 pm

Re: General concepts

Postby jaspreet.frm » Tue May 15, 2012 10:25 pm

Hi Manish

I agree that language of Question 4 is not very clear. It should have been:

Shares of a company are trading at $40. The probability of an upward movement of $5 in a month is 60% and that of downward movement of $5 in a month is 40%. What are the mean and standard deviation of the price after 2 months assuming that the prices are not affected by the rise or fall in the previous month.

But you can still infer from the question that it is for more than one month because it has assumed that prices are not affected by rise or fall in previous month.

Let me know if you require further clarification on calculation part.


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