25.John Williamson is a recently retired executive from Reston Industries. Over the years he has accumulated $10 million worth of Reston stock and another $2 million in a cash savings account. He hires Frank Potter, CFA, a financial adviser from Star Financial, LLC, to help him with his investment strategies. Potter has a number of interesting investment strategies for Williamson's portfolio. Many of the strategies include the use of various equity derivatives. Potter's first recommendation includes the use of a total return equity swap. Potter outlines the characteristics of the swap in Table 1. In addition to the equity swap, Potter explains to Williamson that there are numerous options available for him to obtain almost any risk return profile he might need. Potter suggest that Williamson consider options on both Reston stock and the S& 500. Potter collects the information needed to evaluate options for each security. These results are presented in Table 2. Table 1: Specification of Equity Swap Term | 3 years | Notional principal | $10 million | Settlement frequency | Annual, commencing at end of year 1 | Fairfax pays to broker | Total return on Reston Industries stock | Broker pays to Fairfax | Total return on S& 500 Stock Index |
Table 2: Option Characteristics
| Reston | S& 500 | Stock price | $50.00 | $1,400.00 | Strike price | $50.00 | $1,400.00 | Interest rate | 6.00% | 6.00% | Dividend yield | 0.00% | 0.00% | Time to expiration (years) | 0.5 | 0.5 | Volatility | 40.00% | 17.00% | Beta Coefficient | 1.23 | 1 | Correlation | 0.4 |
|
Table 3: Regular and Exotic Options (Option Values)
| Reston | S& 500 | European call | $6.31 | $6.31 | European put | $4.83 | $4.83 | American call | $6.28 | $6.28 | American put | $4.96 | $4.96 |
Table 4: Reston Stock Option Sensitivities
| Delta | European call | 0.5977 | European put | -0.4023 | American call | 0.5973 | American put | -0.4258 |
Table 5: S& 500 Option Sensitivities
| Delta | European call | 0.622 | European put | -0.378 | American call | 0.621 | American put | -0.441 |
Williamson would like to consider neutralizing his Reston equity position from changes in the stock price of Reston. Using the information in Tables 3 and 4 how many standard Reston European options would have to be bought/sold in order to create a delta neutral portfolio? A) Sell 497,141 put options. B) Buy 370,300 call options. C) Sell 370,300 call options. D) Buy 497,141 put options. The correct answer was D) Number of put options = (Reston Portfolio Value/Stock PriceReston)/-DeltaPut Number of put options = ($10,000,000/$50.00)/-0.4023 = -497,141 meaning buy 497,141 put options. Selling put options does not deliver any downside protection but it aggravates the losses when the stock decreases in value. Buying call options will increase the exposure to Reston.
26.Williamson is very interested in the total return swap. He asks Potter how much it would cost to enter into this transaction. Which of the following is the cost of the swap at inception? A) $45,007. B) $340,885. C) $1,200,460. D) $0. The correct answer was D) Swaps are priced so that their value at inception is zero. 27.Williamson likes the characteristics of the swap arrangement in Table 1 but would like to consider the options in Table 3 before making an investment decision. Given Williamson's current situation which of the following option trades makes the most sense in the short-term (all options are on Reston stock)? A) Buy at the money put options. B) Sell at the money call options. C) Buy out of the money call options. D) Sell in the money put options. The correct answer was A) Buying at the money put options greatly reduces Williamson's downside risk. Selling put options yields an option premium to the seller but increases risk. Selling call options yields an option premium to the seller but does not deliver any downside protection and limits the upside potential of the portfolio. | 
发表于 2008-4-22 13:26
| 