Some firms face risks that they cannot efficiently hedge using plain vanilla options. This motivates them to resort to exotic options. For example, consider a basket option where the underlying asset is the average between the FTSE 100 (main UK stock index) and the S&P 500 (main US index). This contract is well-suited for a company that has its investments equally split between the UK and US stock market. Other exotic options have an even more peculiar design (contract specification, payoff, etc.) so as to meet very particular hedging needs. What are the two most interesting examples you can think of? Describe the underlying risk that a firm wants to hedge and how the exotic option provides an efficient insurance against it.

Some firms face risks that they cannot efficiently hedge using plain vanilla options. This motivates them to resort to exotic options. For example, consider a basket option where the underlying asset is the average between the FTSE 100 (main UK stock index) and the S&P 500 (main US index). This contract is well-suited for a company that has its investments equally split between the UK and US stock market. Other exotic options have an even more peculiar design (contract specification, payoff, etc.) so as to meet very particular hedging needs. What are the two most interesting examples you can think of? Describe the underlying risk that a firm wants to hedge and how the exotic option provides an efficient insurance against it.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter21: Risk Management

Section: Chapter Questions

Problem 7QTD

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Select all of the following statements that accurately compare or contrast forwards and options: Group of answer choices Taking naked long positions in either a call or forward will lead to an overall long position in the underlying security. Options and forwards always have identical payoffs if the spot price remains the same. Both options and forwards can be used to reduce exposure to foreign exchange risk. Going long a naked put option and going short a naked forward both cause unlimited liability. Both options and forwards require the payment of a premium at the initiation of the contract. Forward contracts impose obligations on both parties in the transaction. Options contracts only impose an obligation on one party.
1. According to the efficient market hypothesis (EMH), in a perfect market, the security prices reflect the true and fair value of all the underlying securities' assets at any time. On the contrary, an inefficient market is a market whose security price at any time does not entirely reflect the value of its assets. In this form of market, traders can beat the market because they can employ strategies like arbitrage and speculation. Explain with example, the price reactions towards the bad news that indicate market is inefficient.
Which is correct about security valuation? A. In an efficient market, several factors would affect the market and value is not necessarily equals the price. B. The value of the security is determined to compare it with the current market price and usually investor would buy when the value equals the price. C. Sellers would prefer the accept lower bid price than higher bid price to realize gains. D. Investors buy securities when securities are underpriced and sell them when it is overpriced. E. All of the above F. None of the above
Arbitrage is the idea that one can (select the best answer): Group of answer choices Buy and Sell different assets or packages of assets at different prices such you can earn a riskless profit without investing any capital. Earn rates of return greater than the average for the market by successfully “picking” stocks. Earn abnormal returns above what CAPM would predict for a particular security.
Suppose your client says, “I am invested in Japanese stocks but want to eliminate my exposure to this market for a period of time. Can I accomplish this without the cost and inconvenience of selling out and buying back in again if my expectations change?”a. Briefly describe a strategy to hedge both the local market risk and the currency risk of investing in Japanese stocks.b. Briefly explain why the hedge strategy you described in part (a) might not be fully effective.
Which of the below statements is false about real options? A. Real options increase firm value B.Investing in a project can be priced as an American call option C.Abandoning a project can be priced as an American put option D.Growth options have no impact on the market value of the firm
Solve both questions with no plagiarism
I have been working on the question below and I'm stuck on how to finish it up. I have provided what I've done so far. Is what I've done so far correct? And how do I finish up the problem? Here is the question: Suppose that C is the price of a European call option to purchase a security whose present price is S. Show that if C>S then there is an opportunity for arbitrage (i.e. risk-less profit). You may assume the interest rate is r=0 so that the present value calculations are unnecessary. My work so far: There is an opportunity for arbitrage if we can create a portfolio that initially (time t=0) generates a zero net cash flow or a cash inflow, but still produce a positive or zero cash inflow at the time of expiration. Assume we are going to short sell one call option C, and buy one stock S. Consider the cash flows at time t=0.Cash flow of selling one call option: +CCash flow of buying one stock: -STherefore, since C>S, we have an initial cash inflow of C-S>0. We will now…
Suppose that C is the price of a European call option to purchase a security whose present price is S.Show that if C > S then there is an opportunity for arbitrage (i.e. riskless profit). You may assume theinterest rate is r = 0 so that present value calculations are unnecessary.
There are two styles of option available: European and american a) the american style is normally more expensive than the european style for the same asset, exercise price and date b) options exchanges either offer european or american but not both c) the american style optionsare more lucrative for hedgers d) all of the above
You own Honeywell stock, and are worried that its price will fall. You are considering "insuring" yourself against this possibility. How can your provide such protection? (Choose the best answer below.) A. To protect against Honeywell's stock price dropping, you can buy a put with Honeywell as the underlying asset. B. To protect against Honeywell's stock price dropping, you can sell a call with Honeywell as the underlying asset. C. To protect against Honeywell's stock price dropping, you can buy a call with Honeywell as the underlying asset. D. To protect against Honeywell's stock price dropping, you can sell a put with Honeywell as the underlying asset.
Suppose that C is the price of a European call option to purchase a security whose present price is S. Show that if C>S then there is an opportunity for arbitrage (i.e. risk-less profit). You may assume the interest rate is r=0 so that the present value calculations are unnecessary.