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    437 Midterm 14S S

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    kelerong
    This document contains solutions to exam problems about derivatives pricing. It discusses: 1) Calculating the fixed rate on an interest rate swap using zero coupon bond prices. The rate is 3.08%. 2) Valuing an existing swap as the premium over par for a 5% coupon bond, which equals $4,500,000. 3) Constructing positions in bond forwards and stock forwards to create a short bond position and long stock position that cancel each other out. 4) Finding the proper forward price of $80 for a flexible delivery contract by equating the value to a portfolio of options. 5) Applying put-call parity to value a call option at $5 by

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    437 Midterm 14S S

    Uploaded by

    kelerong
    48 views4 pages
    This document contains solutions to exam problems about derivatives pricing. It discusses: 1) Calculating the fixed rate on an interest rate swap using zero coupon bond prices. The rate is 3.08%. 2) Valuing an existing swap as the premium over par for a 5% coupon bond, which equals $4,500,000. 3) Constructing positions in bond forwards and stock forwards to create a short bond position and long stock position that cancel each other out. 4) Finding the proper forward price of $80 for a flexible delivery contract by equating the value to a portfolio of options. 5) Applying put-call parity to value a call option at $5 by

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    437 Midterm 14S S

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    This document contains solutions to exam problems about derivatives pricing. It discusses: 1) Calculating the fixed rate on an interest rate swap using zero coupon bond prices. The rate is 3.08%. 2) Valuing an existing swap as the premium over par for a 5% coupon bond, which equals $4,500,000. 3) Constructing positions in bond forwards and stock forwards to create a short bond position and long stock position that cancel each other out. 4) Finding the proper forward price of $80 for a flexible delivery contract by equating the value to a portfolio of options. 5) Applying put-call parity to value a call option at $5 by

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    48 views4 pages

    437 Midterm 14S S

    Uploaded by

    kelerong
    This document contains solutions to exam problems about derivatives pricing. It discusses: 1) Calculating the fixed rate on an interest rate swap using zero coupon bond prices. The rate is 3.08%. 2) Valuing an existing swap as the premium over par for a 5% coupon bond, which equals $4,500,000. 3) Constructing positions in bond forwards and stock forwards to create a short bond position and long stock position that cancel each other out. 4) Finding the proper forward price of $80 for a flexible delivery contract by equating the value to a portfolio of options. 5) Applying put-call parity to value a call option at $5 by

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    © All Rights Reserved
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    Download as docx, pdf, or txt
    of 4

    15.

    437

    Spring 2014
    J.C. Cox

    SOLUTIONS
    FOR
    THE MIDTERM EXAM

    1)

    Let Zj be the price of a zero coupon bond with j semiannual periods

    remaining.

    The current value per dollar of principal of a floating rate

    payment to be received

    j semiannual periods from now is (Zj-1 Zj) . The

    fixed rate, X , of the swap must be set so that the current value of the fixed
    payments equals the current value of the floating payments. This requires
    that
    (X / 2) [ Z1 + Z2 + Z3 + Z4] = 2 (Z2 - Z3) + 2 (Z3 Z4) .
    The proper fixed rate for the swap is 3.08%.

    2)

    Your firms swap is equivalent to being long a 5% fixed coupon bond

    and short a floating rate bond. Since the floating rate bond has a value of par
    on reset dates, the value of the swap is the premium over par for a 5% bond.
    Equivalently, the value of your swap can be expressed in terms of an annuity.
    A newly initiated 4% swap has a value of zero. The positive value of your
    swap comes from the additional 1% per year your firm will receive over the
    next five years.
    Let A be the current value of a five-year annuity making semiannual
    payments of $1 per year.

    Given the current swap rate, a bond with

    semiannual coupons of 4% per year will sell for par. The value of this bond
    can be viewed as the value of the coupons plus the value of the principal, so
    .04 (100,000,000) A + .82 (100,000,000) = 100,000,000
    A = 4.5
    The value of the swap is
    .01 (100,000,000) A = 4,500,000 ,

    which is the same as the premium over par for a 5% bond with a principal of
    $100,000,000.

    3)

    Your goal is to use the forwards to construct a short position in the

    thirty-year bond and a long position in two shares of stock. A short position
    in the thirty-year bond is equivalent to a short position in one bond forward
    and a short position in a one-year zero coupon bond with a principal of
    $(98+10).

    A long position in two shares of stock is equivalent to a long

    position in two equity forwards and a long position in a one-year zero coupon
    bond with a principal of $2(54). The zero coupon bond positions cancel out, so
    you should be long two equity forwards and short one bond forward.

    4)

    The proper forward price for the standard contract is the striking price

    for which the put and call are equal. The proper forward price is thus $100.
    With the flexible contract, the seller will choose to deliver as little as possible
    when the final spot price exceeds the forward price and as much as possible
    when the final spot price is less than the forward price. Letting S* be the
    final spot price and F be the forward price, the value of the contract on the
    delivery date can be written as

    75 (S* F)

    if S* > F

    125 (S* F)

    if S* F

    This same final payoff is provided by a portfolio that is long 75 calls and short
    125 puts, each with a striking price of F. The proper forward price is thus the

    striking price for which the price of 75 calls equals the price of 125 puts.
    From the table, we find that the proper forward price for the flexible contract
    is $80.

    5)

    This question can be answered with exactly the same reasoning that

    led to the put - call parity relation. Buying the call is equivalent to buying
    the put, buying one share of DEF, and shorting one share of XYZ. The proper
    value of the call is thus $( 15 + 90 100) = $5. The zero coupon bond price is
    irrelevant; it has no role in answering the question because here the present
    value of the striking price is simply the current price of one share of XYZ.

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