option pricing quiz 2

madhuri1682
Good Student
Posts: 29
Joined: Thu Oct 04, 2012 2:09 am

option pricing quiz 2

Postby madhuri1682 » Sun Nov 04, 2012 12:49 pm

A European-style call spread consists of a long position in the 105 strike call and a short position in the 115 strike call both maturing in 18 months. The options are on a stock index with an annualized dividend yield of 1% per annum. The interest rates are 4% (annual compounding) for 1 year and 5% (annual compounding) for 2 years. Under these circumstances, what is the number nearest the maximum value of this position today?
Choose one answer.
a. 9.5
b. 10
c. 9.29
d. 9.4
how to calculate?

Tags:

content.pristine
Finance Junkie
Posts: 356
Joined: Wed Apr 11, 2012 11:26 am

Re: option pricing quiz 2

Postby content.pristine » Tue Nov 06, 2012 1:57 pm

This is a bull spread using calls.
Luckily, this question is not complicated by premiums in the question.
Now, the max profit happens when the the underlying rises beyond the higher strike price of call.
Hence, lets take a value of 120.
Payoff from first call = 120- 105 = 15
Payoff from second call = 115-120 = -5
Hence P&L = 10.

We have finished quiet a number of excel sheets that help you understand option strategies and other concepts better. Take a look at the free downloads for FRM page sometime tomorrow as they will get uploaded today.

8-)

swarnendupathak
Finance Junkie
Posts: 119
Joined: Mon Sep 17, 2012 11:06 am

Re: option pricing quiz 2

Postby swarnendupathak » Tue Nov 06, 2012 2:05 pm

Thats fine... but this value is after 18 months..don't we need to discount it to today's date???

Swarnendu

madhuri1682
Good Student
Posts: 29
Joined: Thu Oct 04, 2012 2:09 am

Re: option pricing quiz 2

Postby madhuri1682 » Tue Nov 06, 2012 7:10 pm

what are the use of values of interest rates and yield given in this question?

content.pristine
Finance Junkie
Posts: 356
Joined: Wed Apr 11, 2012 11:26 am

Re: option pricing quiz 2

Postby content.pristine » Thu Nov 08, 2012 1:52 pm

Good Point Swarnendu.
Yes. This needs to be discounted.
Thanks for pointing that out!

8-)

swarnendupathak
Finance Junkie
Posts: 119
Joined: Mon Sep 17, 2012 11:06 am

Re: option pricing quiz 2

Postby swarnendupathak » Thu Nov 08, 2012 1:56 pm

But to be discounted at what rate???? as we need to discount it for 18months & the rates are mentioned for 1 year & 2 years???? Please clarify

Swarnendu

content.pristine
Finance Junkie
Posts: 356
Joined: Wed Apr 11, 2012 11:26 am

Re: option pricing quiz 2

Postby content.pristine » Fri Nov 09, 2012 2:20 pm

Since the we need the interest rate for 18 months, we need to interpolate.
The interest rate for 1 year + int rate for 6 months after that
1 dollar invested will give:
1*e^(0.04+0.025)=1.067159
You can directly use this as the denominator to discount.
8-)

swarnendupathak
Finance Junkie
Posts: 119
Joined: Mon Sep 17, 2012 11:06 am

Re: option pricing quiz 2

Postby swarnendupathak » Fri Nov 09, 2012 2:22 pm

Thanks....


Return to “FRM Part I”



cron

Disclaimer

Global Association of Risk Professionals, Inc. (GARP®) does not endorse, promote, review or warrant the accuracy of the products or services offered by EduPristine for FRM® related information, nor does it endorse any pass rates claimed by the provider. Further, GARP® is not responsible for any fees or costs paid by the user to EduPristine nor is GARP® responsible for any fees or costs of any person or entity providing any services to EduPristine Study Program. FRM®, GARP® and Global Association of Risk Professionals®, are trademarks owned by the Global Association of Risk Professionals, Inc

CFA Institute does not endorse, promote, or warrant the accuracy or quality of the products or services offered by EduPristine. CFA Institute, CFA®, Claritas® and Chartered Financial Analyst® are trademarks owned by CFA Institute.

Utmost care has been taken to ensure that there is no copyright violation or infringement in any of our content. Still, in case you feel that there is any copyright violation of any kind please send a mail to abuse@edupristine.com and we will rectify it.