Assignment_2

Financial Risk Management

Submission Date: 24 March 2023
1. Given the following information, calculate the price of a call option on a zero-coupon
bond with three years to maturity:
Strike price $88.00
Time to expiration 2 years
Current price of bond $83.96 (assuming for simplicity annual compounding)
Expected return volatility 10%
Risk-free rate 6%
What will be the value of the call if the strike price is $100.25 instead of $88.00.
2. (a) What is the value at risk, and how is it measured? The expected annual return for a
100,000,000 portfolio is 6.0o/o and the historical standard deviation is 12o/o. Calculate
VAR at 5o/o significance. Compute the weekly Var at 1%.
(b) The following are fourteen daily observations on the AUD/USD exchange rates
1.1900, 1.25000, 1.2180, 1.1870, 1.1750, 1.2045, 1.2338, 1.2400, 1.2080, 1.2000,
1.2442, 1.2620, 1.2100, 1.1900. On the basis of this sample, calculate the VAR of a
AUD1 000 000 position on the US dollar, using the parametric approach and the
historical approach. For this purpose, use a time horizon of one day and a probability
of 1 per cent.
3. (a) Briefly explain an interest-rate swap contract and a currency swap contract. What is
with a currency swap contract with a notional principal?
(b) In December 1992 two companies, A and B, agreed on a five-year currency swap
whereby A receives payments in Australian dollar and B receives payments in
Canadian dollar at contracted exchange rate of 1.0322 (CAD/AUD). The notional
principal of the swap is AUD 500,000. The exchange rate assumed the following
values on the payment dates:

Payment date Exchange rate

December 1993 1.0560
December 1994 1.067
December 1995 1.0120
December 1996 1.000
December 1997 1.0322
Calculate the payments due to A and B on each payment date. Use the table below.

Payment A B
Exchange rate
date A receives B receives receives receives
Dec-93 1.056
Dec-94 1.067
Dec-95 1.012
Dec-96 1
Dec-97 1.0322
4. In the Table given below, following information are provided on prices of options on
Intel, January 24, 2022 (strike price = $51.98) with the maturities March 2022, May
2022, and July 2022. The March options have an expiration date of March 18, 2022; the
May options have an expiration date of May 20, 2022; and the July options have an
expiration date of July 15, 2022.

Suppose an investor instructs a broker to buy one May call option contract on Intel’s stock
with a strike price of $52.50 and one July put option contract with a strike price of $50.
(i) What is the amount that the investor must arrange to be remitted to the exchange
through the broker for the May call and the July put?
(ii) What happens if the Intel share price is $60 on May 20? What if the Intel share price
is $40 on July 15?
5. (a) Briefly describe duration, and how a security’s duration is measured.
(b) A bond has par value of $1,000, a 10% semiannual coupon, and four years to
maturity. If the yield to maturity on this bond is 8% and its current price is
$1,067.34, calculate the duration of this bond?
(c) What happens to the duration, if the annual coupon rate on this bond is reduced to
6%?