932N1 FINANCIAL DERIVATIVES
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932N1
MSc Report
April (A2)
FINANCIAL DERIVATIVES
1. There are four questions in this assessment, but only TWO should be answered, the question in section A (worth 80 marks) and one of the three questions in section B (worth 20 marks).
2. The word count must be printed on the first page of the project: 3000 土10%, exclud- ing mathematical formulas, bibliography, and appendices (if applicable).
3. Please note that this is NOT a group exercise. You are not allowed to discuss the questions with others, so the answers to questions must be worked out and written up individually. You may receive reduced or no marks if there are strong similarities between the work handed in by two or more people.
4. If any, your answer to each question should include the full reference for all articles, books and other sources you have cited in the body of the text.
5. Note that your answer files, consisting of ONE Word document and ONE Excel file (or Matlab/python code) showing all the calculations, are to be submitted electroni- cally via the "E-submissions" link on the module’s Canvas site by the deadline. The maximum number of files allowed to be submitted is FOUR.
6. Please check carefully the deadline for the project on Canvas/Sussex Direct. Late submissions will be treated according to university regulations. More information on assessment regulations can be found here:
http://www.sussex.ac.uk/adqe/standards/examsandassessment/esubmission
SECTION A
There is ONE questions in this section. You must attempt this question.
This section is worth 80 marks.
1. The attached file “BRC_LOGN.pdf” provides information on an option-based structured security issued by Credit Suisse, the Barrier Reverse Convertible Note (or BRC), written on the share price of Logitech International S.A. (RIC: LOGN.S), maturing on 7 March 2024.
As a competitor, your bank is planning to issue a similar structured product, denominated in USD, written on the share price of Advanced Micro Devices INC (RIC: AMD.O). For simplicity, the product will have the same initial fixing date and the payment date on 7 March 2023, and the same final fixing date and redemption date on 7 March 2024. Apart from this, the product has identical structure as the one issued by Credit Suisse. You are planning to market it as Simple Barrier Reverse Convertible (SBRC).
(a) Explain what a European down-and-out barrier put option is. Can it be
replicated by a set of other option contracts? If yes, how? If not, why not? [ 10 marks ]
(b) Explain what the term “implied volatility” means. Estimate the at-the-money
(ATM) implied volatility for AMD.O on 7 March 2023 using data downloaded from the Refinitiv Workspace. [ 10 marks ]
(c) Using a 12-step binomial tree and the Cox-Rubinstein-Ross parametrisation, price an at-the-money (ATM) European down-and-out barrier put option on 7 March 2023, with the maturity of one year and the barrier at 60% of the AMD stock price. State clearly your assumptions and data used. [ 15 marks ]
(d) Assume a money market account is available. Vanilla and Exotic options are available for any strike prices on the AMD share. Provide two ways to construct the payoff of SBRC. [ 15 marks ]
(e) Provide a competitive bid and ask price (in USD) for the SBRC, using the AMD
share price and option prices downloaded from Refinitiv Workspace. State clearly the prices used, the assumptions made, and the modelling framework. [ 30 marks ]
SECTION B
There are three questions in this section. You must attempt ONE of them.
This section is worth 20 marks.
2. Continue from Question 1: As the writer of the SBRC, your employer wishes to know the risk characteristics of the product with respect to future changes in the market.
(a) Using the Black-Scholes model or basic numerical methods, calculate the
Greeks (delta, gamma, vega, theta, rho) for SBRC, and clearly state your assumptions. Interpret your findings, and provide hedging strategies for the writer of the product. [ 10 marks ]
(b) Estimate the P&L distribution for your employer at the maturity of the SBRC, under different assumptions on the index growth rate and index return volatility. Interpret and critically assess your calculations. [ 10 marks ]
3. Continue from Question 1: Instead of the 8% p.a. quarterly coupon payment in the BRC issued by Credit Suisse, you are adjusting the yield for the SBRC so that it reflects the characteristics of the underlying AMD stock price, as well as the interest rate in the U.S. Propose a competitive coupon payment and subscription fee structure. [ 20 marks ]
4. Cotton is considered to be a recession-sensitive commodity. Despite the 40% increase to in the first half of 2022 due to the Russo-Ukrainian war, there has been a massive price plunge since May 2022 (RIC: TTAc#). Analyse the month-end valuation and forward curve characteristics of cotton in March 2022, September 2022, and February 2023. Discuss the supply and demand effect implicit in the dynamics of the forward curve. (Note: Approximate word count expected from this question is 500 words.) [ 20 marks ]
2023-03-20