Microsoft Word - Finance Assignment.docx
Total Marks: 50 marks
GUIDELINES: ASSIGNMENT LAYOUT AND PRESENTATION
Your document should be typed in Times New Roman font, size 12.
The assignment should be double spaced and have margins of 2.54 cm.
For calculation questions, you need to show all your workings (including timeline if
appropriate) and round your answers to three decimal places.
Question 1 (5 Marks)
(i) The stock of Company ABC is cu
ently trading at a price of $50. According to analyst
forecasts, the share price will be either $45 or $55 at the end of six months. Suppose that
the risk-free interest rate is 10% per annum with continuous compounding. What is the
value of a six-month European put option with a strike price of $50 using the Delta-hedging
method?
(3 marks)
(ii) Verify your result in part (i) using the Risk-neutral method.
(2 marks)
Question 2 (15 marks)
A stock is cu
ently traded at $60. The standard deviation of the stock return is 30% per annum.
The riskless interest rate is 5% per annum. The terminal payoff of the derivative is specified
as:
Payoff = 3 ST + 10
(i) Suppose that the derivative is a knock-out option with one year remaining. The ba
ier is set
at $80. Construct a four-step binomial tree to price this ba
ier option. (6 marks)
(ii) Suppose that the derivative is a knock-in option with one year remaining. The ba
ier is set
at $80. Construct a four-step binomial tree to price this ba
ier option. (6 marks)
(iii) Suppose that the derivative is a normal European style option with one year remaining (i.e.,
it does not have the ba
ier). Without constructing a binomial tree, what is the price of this
European option? Justify your answers. (3 marks)
Question 4 (17 Marks)
For a levered firm, firm’s assets are financed by equity and debt.