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FIN405 Assignment 1

This document provides instructions for Assignment 1 for a Derivatives course. It includes questions about option pricing using a binomial model, the concept of moneyness, and the differences between American and European options. For question 1, students are asked to calculate option prices using a one period binomial model. For question 2, students must explain moneyness. Question 3 requires students to discuss the differences between American and European options. The assignment is due by the end of week 7 and must be submitted in Word format via Blackboard.

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Memoona Nawaz
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37 views6 pages

FIN405 Assignment 1

This document provides instructions for Assignment 1 for a Derivatives course. It includes questions about option pricing using a binomial model, the concept of moneyness, and the differences between American and European options. For question 1, students are asked to calculate option prices using a one period binomial model. For question 2, students must explain moneyness. Question 3 requires students to discuss the differences between American and European options. The assignment is due by the end of week 7 and must be submitted in Word format via Blackboard.

Uploaded by

Memoona Nawaz
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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College of Administrative and Financial Sciences

Assignment 1

Academic Year: 2nd-2021-2022-1442/1443 H


Course Name: Derivatives Student’s Name:
Course Code: FIN405 Student’s ID Number:
Semester: 2 Semester CRN:25531

For Instructor’s Use only


Instructor’s Name:

Students’ Grade: Marks Obtained/Out of Level of Marks: High/Middle/Low

Instructions – PLEASE READ THEM CAREFULLY


 The Assignment must be submitted on Blackboard (WORD format only) via allocated
folder.
 Assignments submitted through email will not be accepted.
 Students are advised to make their work clear and well presented; marks may be reduced
for poor presentation. This includes filling your information on the cover page.
 Students must mention question number clearly in their answer.
 Late submission will NOT be accepted.
 Avoid plagiarism, the work should be in your own words, copying from students or other
resources without proper referencing will result in ZERO marks.
 All answered must be typed using Times New Roman (size 12, double-spaced) font.
 Submissions without cover page will NOT be accepted.
Assignment 1
Submission Date by students: End of week-7 (12/03/2022 )-11:59 PM
Place of Submission: Students Grade Centre via blackboard.
Marks: 10 Marks

Assignment Purposes/Learning Outcomes:

LO 1. Recognize call and put options and their use in investment management.

LO 2. Describe trading strategy which incorporates the use of call and put options.

Assignment Question(s): (Marks 10)

Q-1. The current stock price be SAR 50 and that can go up or down by 20 percent per period. The

risk-free rate is 10 percent. Use one binomial period. (5 Marks)

Current stock price = 50

Size of up-move = 1+ 2%

= 1.2

Size of down-move = 1-20%


= 0.8

Two possibilities

50× 1.2 = 60 ------ Equation 1

50 × 0.8 = 40 ------ Equation 2

= 1 + risk free rate –size of down move / (size of up move)- (size of down move)

= 1+0.10-0.8 / 1.2 -0.8

= 0.3 /0.4

= 0.9

Pd = 1- P4

= 1-0.9

= 0.1

a) Determine the two possible stock prices for the next period. (1 Mark)

 Call value for up-move = 10

 Call value for move-down = 0

b) Determine the intrinsic values at expiration of a European call option with an exercise price of

SAR 45. (1.5 Marks)

Part B:

Intrinsic value at price g SAR45


= (10× 0.9) + (0×0.1)

= 9=0

=9

c) Find the value of the option today. (1.5 Marks)

Part C:

= 9/1.1

=8.18

So, call trading is at =8.18

d) Calculate the hedge ratio. (1 Mark)

Part D:

Hedge ratio = P4 –Pd/ uSo – dSo

= 10-0/60-40

= 10/20

= 0.50
Q-2.Explain the concept of moneyness; (3Marks)

Moneyness:

Moneyness is basically a description of some derivative describing its strike price and to

the price of its underlying asset. The Moneyness describes the intrinsic value of any option in its

current state.

The term moneyness is which describe the relationship between the spot price of

underlying asset and then the strike price as well which is also pre-determined price and also the

premium.

The clear understanding of the term moneyness is that the correct option in the given

situation is chosen. This is one of the most used terminology and all the trading strategies stem

from the moneyness. The decision making process is impacted by this process.

Q-3.Explain the Options and discuss the difference between American and European options.

(2 Marks)

The main difference between the American and European option is that when the option

can be exercised. The European option can only be exercised when the expiration date of the

option is due an example for European option is that a single predefined point in times. The

American option is that it can be exercised at any point before expiration.

Also the American option has more price, and also the premium is higher than the

European option and it also give the right to the option holder to exercise the contract before the

expiration date.

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