Financial Derivatives Handout

Name:______Date:______

1) Its Super Bowl XLII between the Patriots and the Giants. The Patriots are favored 4-1 to win the game and your friend places a $1,000 bet on the Giants to win the game. Answer the following questions.

a. How much would you pay to your friend for the option to purchase his bet? (Hint: There is no single right answer)

b. Would you pay him more than $1,000 for this option at the start of the game?

c. The Giants are winning 3-0 at the end of the first quarter, how would the price of the option change? (increase, decrease, remain the same)

d. The Patriots are now winning 14-10 with 2:42 left in the game, how would the price of the option change? (increase, decrease, remain the same)

e. The Giants scored a late touchdown to take a 17-14 lead with 0:35 left in the game, would you pay him more than $1,000 for this option? 2) You are a Patriots fan and bet $4,000 on them to win the game (remember the odds are 1- 4 so the payout is only $1,000). It’s the end of the 3rd Quarter and the Patriots are only up by 4 points. You want to hedge your risk and find someone to sell you a $500 option on a $1,000 bet that the Giants win. Answer the following questions.

a. How much would you win / lose if the Patriots win/ lose

a.i. Patriots win:

a.ii. Patriots lose:

b. How much would you have had to wager without options if you wanted to win $500?

3) Identifying Options: Google’s stock price is $570 and Bill has bought 3 option contracts for $15 ($5 per contract) with a strike price of $580. Answer the following questions.

a. If the stock price goes above $600 Bill will exercise the option, what has he bought?

b. How much money will he make?

4) Identifying Options: Google’s stock price is $570 and Bill has written 3 option contracts for $9,000 ($3,000 per contract) with a strike price of $600. Answer the following questions.

a. If the stock price goes down to $560 Bill is forced to exercise the option, what has he written?

b. How much will he lose? 5) Calculate the Value of the CALL option using the simplified binomial options pricing model.

S = $100 Strike = $100 σ = 25% t = .25

Rf = 5%

(a) Find the values of Su and Sd and write them in the tree below:

σ√t .25√ (.25) -σ√t 1 u = e = e = d = e = /u =

Su = S * u = Sd = S * d =

(b) Calculate the value of the call option at the end nodes and write them in the tree

Vud = MAX [0, Sud - Strike -] = MAX [0, 100 - 100] = 0

Vuu = (c) Calculate the value of the option today assuming p =.5 (remember r = 5%, and t=.25)

(- r × t) Formula to be used is: Max [(S – Strike), p × Vu+ (1-p) × Vd] × e