Question 3 Stock name :ABC Financial Berhad Stock price (current) Dividend yield : RM5.00 : 8% You are currently holding RM500,000 worth of shares in ABC Financial Berhad, which is involved in banking and financial services in Malaysia. However, you foresee that Bank Negara Malaysia (BNM) will decrease the interest rate and extend the moratorium due to COVID-19 outbreak. Therefore, you are worried that an interest rate reduction will cause a decline in share prices. To eliminate the risk, you have decided to temporarily hedge against it with one of the derivatives below for 3 months: Alternative 1: Hedge with stock futures: Current market price of ABC Financial Berhad. 3-month ABC Financial Berhad. futures price Initial margin Contract size : RM5.00 : RM5.20 : 10% : 1,000 shares per contract Alternative 2: Hedge with put options: Current market price of ABC Financial Berhad. 3-month ABC Financial Berhad put option strike price : RM5.20 3-month ABC Financial Berhad put option premium : RM5.00 : RM0.70 per share : 100 shares per contract Contract size
Question 3 Stock name :ABC Financial Berhad Stock price (current) Dividend yield : RM5.00 : 8% You are currently holding RM500,000 worth of shares in ABC Financial Berhad, which is involved in banking and financial services in Malaysia. However, you foresee that Bank Negara Malaysia (BNM) will decrease the interest rate and extend the moratorium due to COVID-19 outbreak. Therefore, you are worried that an interest rate reduction will cause a decline in share prices. To eliminate the risk, you have decided to temporarily hedge against it with one of the derivatives below for 3 months: Alternative 1: Hedge with stock futures: Current market price of ABC Financial Berhad. 3-month ABC Financial Berhad. futures price Initial margin Contract size : RM5.00 : RM5.20 : 10% : 1,000 shares per contract Alternative 2: Hedge with put options: Current market price of ABC Financial Berhad. 3-month ABC Financial Berhad put option strike price : RM5.20 3-month ABC Financial Berhad put option premium : RM5.00 : RM0.70 per share : 100 shares per contract Contract size
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Required
(a)Discuss TWO (2) rationales of hedging with a derivative instead of disposing of the shares at market price.
(b) Calculate the number of contracts and determine the strategy to hedge against your riskexposure with each of the alternatives above.
(c) Assume that it is out of your expectation that the interest rate does not decline and ABC Financial Bhd.’s share price appreciated to RM7.00 due to economic recovery.
Compute the payoff for both alternatives above and determine the better alternative with appropriate justification.
Transcribed Image Text:Question 3
: ABC Financial Berhad
: RM5.00
: 8%
Stock name
Stock price (current)
Dividend yield
You are currently holding RM500,000 worth of shares in ABC Financial Berhad, which is involved in
banking and financial services in Malaysia. However, you foresee that Bank Negara Malaysia (BNM)
will decrease the interest rate and extend the moratorium due to COVID-19 outbreak. Therefore, you
are worried that an interest rate reduction will cause a decline in share prices.
To eliminate the risk, you have decided to temporarily hedge against it with one of the derivatives
below for 3 months:
Alternative 1: Hedge with stock futures:
Current market price of ABC Financial Berhad.
3-month ABC Financial Berhad. futures price
Initial margin
: RM5.00
: RM5.20
: 10%
: 1,000 shares per contract
Contract size
Alternative 2: Hedge with put options:
Current market price of ABC Financial Berhad.
3-month ABC Financial Berhad put option strike price : RM5.20
3-month ABC Financial Berhad put option premium
Contract size
: RM5.00
: RM0.70 per share
: 100 shares per contract
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