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    1 - Week Three Financial Engeneering Assignment

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    aS hausj
    Chapter 7 discusses interest rate swaps and describes 4 examples of swaps between companies needing to exchange fixed and floating rate loans or investments. The swaps are designed such that a bank acting as intermediary earns a small net interest rate in each case. Chapter 8 discusses securitization and the 2007 credit crisis. Chapter 9 defines put and call options and uses examples and diagrams to illustrate how an option holder's profit varies with the underlying stock price.

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    1 - Week Three Financial Engeneering Assignment

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    aS hausj
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    Chapter 7 discusses interest rate swaps and describes 4 examples of swaps between companies needing to exchange fixed and floating rate loans or investments. The swaps are designed such that a bank acting as intermediary earns a small net interest rate in each case. Chapter 8 discusses securitization and the 2007 credit crisis. Chapter 9 defines put and call options and uses examples and diagrams to illustrate how an option holder's profit varies with the underlying stock price.

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    Chapter 7 discusses interest rate swaps and describes 4 examples of swaps between companies needing to exchange fixed and floating rate loans or investments. The swaps are designed such that a bank acting as intermediary earns a small net interest rate in each case. Chapter 8 discusses securitization and the 2007 credit crisis. Chapter 9 defines put and call options and uses examples and diagrams to illustrate how an option holder's profit varies with the underlying stock price.

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

    1 - Week Three Financial Engeneering Assignment

    Uploaded by

    aS hausj
    Chapter 7 discusses interest rate swaps and describes 4 examples of swaps between companies needing to exchange fixed and floating rate loans or investments. The swaps are designed such that a bank acting as intermediary earns a small net interest rate in each case. Chapter 8 discusses securitization and the 2007 credit crisis. Chapter 9 defines put and call options and uses examples and diagrams to illustrate how an option holder's profit varies with the underlying stock price.

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    © All Rights Reserved
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    of 4

    Chapter 7: Swaps Chapter 7: 1, 9, 12, 20, and 25.

    Chapter 8: Chapter 8: 3, 12, and 18.


    Securitization and the
    Credit Crisis of 2007

    Chapter 9: Mechanics Chapter 9: 1, 2, 12, 17, and 28.


    of Options Markets

    7.1. Companies A and B have been offered the following rates per annum on a
    $20 million five-year loan:
    Fixed rate Floating rate

    Company A: 5.0% LIBOR + 0.1%

    Company B: 6.4% LIBOR + 0.6%

    Company A requires a floating-rate loan; company B requires a fixed-rate loan.


    Design a swap that will net a bank, acting as intermediary, 0.1% per annum and
    that will appear equally attractive to both companies.

    7.9. Companies X and Y have been offered the following rates per annum on a
    $5 million 10-year investment:
    Fixed rate Floating rate

    Company X: 8.0% LIBOR

    Company Y: 8.8% LIBOR

    Company X requires a fixed-rate investment and company Y requires a floating-


    rate investment. Design a swap that will net a bank, acting as intermediary, 0.2%
    per annum and will appear equally attractive to X and Y
    7.12. Companies A and B face the following interest rates (adjusted for the
    differential impact of taxes):
    A B

    U.S. dollars (floating LIBOR + LIBOR +


    rate): 0.5% 1.0%

    Canadian dollars 5.0% 6.5%


    (fixed rate):

    Assume that A wants to borrow U.S. dollars at a floating rate of interest and B
    wants to borrow Canadian dollars at a fixed rate of interest. A financial institution
    is planning to arrange a swap and requires a 50-basis-point spread. If the swap
    is to appear equally attractive to A and B, what rates of interest will A and B end
    up paying?

    7.20. (a) Company A has been offered the rates shown in Table 7.3. It can
    borrow for three years at 6.45%. What floating rate can it swap this fixed rate
    into? (b) Company B has been offered the rates shown in Table 7.3. It can
    borrow for five years at LIBOR plus 75 basis points. What fixed rate can it swap
    this floating rate into?

    Table 7.3 Bid and offer fixed rates in the swap market and swap rates (percent per
    annum); payments exchanged semiannually
    Maturity (years) Bid Offer Swap rate

    2 6.03 6.06 6.045

    3 6.21 6.24 6.225

    4 6.35 6.39 6.370

    5 6.47 6.51 6.490

    7 6.65 6.68 6.665

    10 6.83 6.87 6.850


    7.25. Company A wishes to borrow U.S. dollars at a fixed rate of interest.
    Company B wishes to borrow sterling at a fixed rate of interest. They have been
    quoted the following rates per annum (adjusted for differential tax effects):
    Sterling U.S. dollars

    Company A: 11.0% 7.0%

    Company B: 10.6% 6.2%

    Design a swap that will net a bank, acting as intermediary, 10 basis points per
    annum and that will produce a gain of 15 basis points per annum for each of the
    two companies.

    8.18. Suppose that mezzanine tranches of the ABS CDOs, similar to those
    in Figure 8.3, are resecuritized to form what is referred to as a “CDO squared.”
    As in the case of tranches created from ABSs in Figure 8.3, 65% of the principal
    is allocated to a AAA tranche, 25% to a BBB tranche, and 10% to the equity
    tranche. How high does the loss percentage have to be on the underlying assets
    for losses to be experienced by a AAA-rated tranche that is created in this way.
    (Assume that every portfolio of assets that is used to create ABSs experiences
    the same loss rate.)

    Figure 8.3 Creation of ABSs and an ABS CDO from portfoloios of assets
    (simplified)
    9.1. An investor buys a European put on a share for $3. The stock price is $42 and the
    strike price is $40. Under what circumstances does the investor make a profit? Under
    what circumstances will the option be exercised? Draw a diagram showing the variation
    of the investor’s profit with the stock price at the maturity of the option.

    9.2. An investor sells a European call on a share for $4. The stock price is $47 and the
    strike price is $50. Under what circumstances does the investor make a profit? Under
    what circumstances will the option be exercised? Draw a diagram showing the
    variation of the investor’s profit with the stock price at the maturity of the option.

    9.12. A trader buys a call option with a strike price of $45 and a put option
    with a strike price of $40. Both options have the same maturity. The call costs
    $3 and the put costs $4. Draw a diagram showing the variation of the trader’s
    profit with the asset price.

    9.17. Consider an exchange-traded call option contract to buy 500 shares with a
    strike price of $40 and maturity in four months. Explain how the terms of the
    option contract change when there is: (a) a 10% stock dividend; (b) a 10% cash
    dividend; and (c) a 4-for-1 stock split.

    9.28. Use DerivaGem to calculate the value of an American put option on a non-
    dividend-paying stock when the stock price is $30, the strike price is $32, the
    risk-free rate is 5%, the volatility is 30%, and the time to maturity is 1.5 years.
    (Choose “Binomial American” for the Option Type and 50 time steps.)
    a. What is the option’s intrinsic value?
    b. What is the option’s time value?
    c. What would a time value of zero indicate? What is the value of an option with
    zero time value?
    d. Using a trial and error approach, calculate how low the stock price would have to
    be for the time value of the option to be zero.

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