Derivatives & Alts

Question 1

Value of a forward contract at expiration and any time before.

Answer 1

The value of a forward contract at expiration is the price of the spot/asset minus the price of the forward

The value of a forward contract at any time before its expiration is the spot price of the underlying asset, plus the present value of storage costs, minus the present value of monetary and nonmonetary benefits of holding the underlying, minus the present value of the forward price.

The forward price, established when the contract is initiated, is the price agreed to by the two parties that produces a zero value at the start. So value is zero, so price exxeeds value.

Question 2

Describe the relationship between futures and forwards value given the relationship with futures prices and interest rates

Answer 2

futures prices will be higher than forward prices when interest rates and futures prices are positively correlated, and they will be lower than forward prices when interest rates and futures prices are negatively correlated.

If futures prices and interest rates are uncorrelated, the prices of forwards and futures will be identical.

Question 3

No arbitrage condition

Answer 3

Risky asset + derivative = risk free asset

Return is risk free rate.

Question 4

How does a change in the risk free rate impact the value of an option?

Answer 4

Increase in the risk free rate increases the value of a call option

Question 5

Call option valuation using put-call parity

Answer 5

C - P = S - X –> This can be rearranged to create synthetic positions

S = c – p + X / (1 + Rf)^T

p = c – S + X / (1 + Rf)^T

c = S + p – X / (1 + Rf)^T

X / (1 + Rf)^T = S + p – c

Note: pv of strike price = price / (1 + risk free rate) ^ (1/n)
n is 4 for a 3 month option

Note that the options must be European-style and the puts and calls must have the same exercise price and time to expiration for these relations to hold.

The single securities on the left-hand side of the equations all have exactly the same payoffs as the portfolios on the right-hand side. The portfolios on the right-hand side are the synthetic equivalents of the securities on the left.

Question 6

Brownfield vs greenfield

Answer 6

A brownfield investment is an existing asset that likely has operational and financial history to aid in valuation; a greenfield investment is in new construction.

Question 7

Skip

Answer 7

Skip

Question 8

Factors that determine the value of an option

Answer 8

Increase in Risk free rate: Increase value of call, decrease value of put

Increase in volatility: increase value of both

increase time to expiration: increase value of both

increase cost of holding underlying: increase value of call, decrease value of put

increase benefit of holding underlying: decrease value of call, increase value of put

dividends: reduce the value of the underlying, so decrease the value of a call, increase value of put.

Question 9

Fiduciary Call

Answer 9

A fiduciary call is a combination of a long call with exercise price X and a pure-discount, riskless bond that pays X at maturity (option expiration). The payoff for a fiduciary call at expiration is X when the call is out of the money,

Question 10

Protective Put

Answer 10

A protective put is a long asset with a long put option on the stock. The expiration date payoff for a protective put is (X – S) + S = X when the put is in the money, and S when the put is out of the money.

Question 11

A synthetic long bond consist of

Answer 11

a long asset, a long put, and a short call.

Question 12

what’s required for a binomial pricing model

Answer 12

To construct a binomial model, both the spot price of the underlying and two possible prices one period later and the the pseudo or “risk-neutral” probabilities (not actual probabilities) of each of these changes occurring.

the difference between the up and down factors best represents the volatility of the underlying

Question 13

put–call–forward parity

Answer 13

same as C-P = S-X
except you replace the underlying asset, S, with a forward contract.

so replace S with F0(T) / (1 + Rf)^T

Question 14

Mortgage Pass Through

Answer 14

Agency RMBS are mortgage pass-through securities. Represents a claim on the cash flows from a pool of mortgages. The pass-through rate is less than the mortgage rate on the underlying pool of mortgages by an amount equal to the servicing (and other administrative) fees.

Question 15

Difference between American and European Call

Answer 15

American call prices can differ from European call prices only if there are cash flows on the underlying. When an American call option is above the price of a European call option with otherwise identical features, the underlying will go Ex

Think like this Americans can exercise anytime. The price drops after ex date but the Americans can exercise before that. This option makes the price higher

Question 16

In valuing underlying hedge fund positions, the most conservative approach is most likely

Answer 16

one that uses: bid prices for longs and ask prices for shorts.

Question 17

forward commitments vs contingent claims

Answer 17

A forward commitment is a legally binding promise to perform some action in the future. (futures, forwards, and swaps)

A contingent claim is a claim (to a payoff) that depends on a particular event (i.e. options)

Question 18

Define Replication

Answer 18

Replication is the process of creating an asset or portfolio from another asset, portfolio, and/or derivative. It is used to exploit pricing differentials.

Question 19

Price of a forward - fixed or floating?

Answer 19

The price of a forward contract remains constant throughout the life of the contract. It is set as part of the contract specifications.

Question 20

for riskless arbitrage to exist the underlying security

Answer 20

• may be either a financial or a non-financial security.
• must be able to be short sold
• must be relatively liquid so it is easy to buy and sell at a low cost.

Question 21

Describe the impact time has on a forward price

Answer 21

The forward price is the spot price compounded at the risk-free rate over the life of the contract. The longer the life, more compounding will lead to a larger value.

Question 22

Consideration when valuing derivatives

Answer 22

Risk neutrality, not risk aversion, is a key element of derivatives pricing, because derivative’s return is the risk free rate (something like that)

Question 23

Stages of VC Funding

Answer 23

1. Formative-stage financing occurs when the company is still in the process of being formed
   - Angle Investing - capital provided at idea stage
   - seed stage - supports product development and marketing
   - early stage - moving towards operation but before production
2. Later stage - financing after production and sales have begun
3. mezzanine - financing to help company go public.