MAF308 Derivatives and Fixed Income Securities

Trimester 1, 2023

Assessment Task 2: Individual Analytical Report

Due Date and Time: Week 9, 8th May 2023, 8:00PM Melbourne time
Percentage of Final Grade: 40%
Hurdle: N/A

1 Description

This task provides you with opportunities to learn the knowledge (GLO1) and skills (GLO 2,
4 & 5) required in the study and practice of derivative trading and investment. By completing
this task, you will develop your skills in researching, understanding, applying, evaluating, and
presenting information required of business professionals.

2 Learning Outcomes

This task allows you to demonstrate your achievement towards the Unit Learning Outcomes
(ULOs) which have been aligned to the Deakin Graduate Learning Outcomes (GLOs). Deakin
GLOs describe the knowledge and capabilities graduates acquire and can demonstrate on com-
pletion of their course. This assessment task is an important tool in determining your achieve-
ment of the ULOs. If you do not demonstrate achievement of the ULOs you will not be successful
in this unit. You are advised to familiarise yourself with these ULOs and GLOs as they will
inform you on what you are expected to demonstrate for successful completion of this unit.

Page 1 of 18
 The learning outcomes that are aligned to this assessment task are:

Unit Learning Outcome (ULO) Graduate Learning Outcome (GLO)

On Successful Completion of this assessment, stu-
dents can:
ULO1 - Explain the characteristics of financial 1
derivatives and their markets.
ULO2 - Explain the law of one price and mechanics 4, 5
of no arbitrage and apply them in pricing financial
derivatives.
ULO3 - Evaluate investments in forwards, futures, 5
options and swaps contracts.
ULO4 - Evaluate and communicate financial infor- 1, 2, 4, 5
mation professionally using appropriate mathemat-
ical and communication tools.

3 Submission

Submitting a hard copy of this assignment is not required. You must keep a backup copy of
every assignment you submit until the marked assignment has been returned to you. In the
unlikely event that one of your assignments is misplaced you will need to submit your backup
copy.

You must submit your assignment in the Assignment Dropbox in the unit CloudDeakin site
on or before the due date. When uploading your assignment, name your document using the fol-
lowing syntax: <your surname your first name your Deakin student ID number [unitcode]>.
For example, ’Jones Barry 123456789 ABC123’.

This is individual assignment. Your final report is a printable document, being either a
Word document or a PDF document. Marking is based on submitted final report only!

Any work you submit may be checked by electronic or other means for the purposes of
detecting collusion and/or plagiarism and for authenticating work.

When you submit an assignment through your CloudDeakin unit site, you will receive an
email to your Deakin email address confirming that it has been submitted. You should check
that you can see your assignment in the Submissions view of the Assignment Dropbox folder
after upload and check for, and keep, the email receipt for the submission.

Page 2 of 18
4 Marking and feedback

The marking rubric indicates the assessment criteria for this task. It is available in the Cloud-
Deakin unit site in the Assessment folder, under Assessment Resources. Criteria act as a
boundary around the task and help specify what assessors are looking for in your submission.
The criteria are drawn from the GLOs. You should familiarise yourself with the assessment
criteria before completing and submitting this task.

Students who submit their work by the due date will receive their marks and feedback on
CloudDeakin 15 working days after the submission date.

5 Extensions

In T1 2023, MAF308 assignment extension applications are handled by a Faculty designated

staff (NOT Unit Chair!). Extensions can only be granted for exceptional and/or unavoidable
circumstances outside of your control. Requests for extensions must be made by 12 noon on
the submission date using the online Extension Request form under the Assessment tab on the
unit CloudDeakin site. All requests for extensions should be supported by appropriate evidence
(e.g., a medical certificate in the case of ill health).

Applications for extensions after 12 noon on the submission date require University level
special consideration and these applications must be must be submitted via StudentConnect in
your DeakinSync site.

5.1 Late submission penalty

If you submit an assessment task after the due date without an approved extension or special
consideration, 5% will be deducted from the available marks for each day after the due date up
to seven days. Work submitted more than seven days after the due date will not be marked

Page 3 of 18
and will receive 0% for the task. The Unit Chair may refuse to accept a late submission where
it is unreasonable or impracticable to assess the task after the due date. ’Day’ means calendar
day for this assessment task.

An example of how the calculation of the late penalty based on an assignment being due on
a Thursday at 8:00pm is as follows:

ˆ 1 day late: submitted after Thursday 11:59pm and before Friday 11:59pm– 5% penalty.

ˆ 2 days late: submitted after Friday 11:59pm and before Saturday 11:59pm – 10% penalty.

ˆ 3 days late: submitted after Saturday 11:59pm and before Sunday 11:59pm – 15% penalty.

ˆ 4 days late: submitted after Sunday 11:59pm and before Monday 11:59pm – 20% penalty.

ˆ 5 days late: submitted after Monday 11:59pm and before Tuesday 11:59pm – 25% penalty.

ˆ 6 days late: submitted after Tuesday 11:59pm and before Wednesday 11:59pm – 30%
penalty.

ˆ 7 days late: submitted after Wednesday 11:59pm and before Thursday 11:59pm – 35%
penalty.

The Dropbox closes the Thursday after 11:59pm AEST/AEDT time.

6 Support

The Division of Student Life provides a range of Study Support resources and services, available
throughout the academic year, including Writing Mentor and Maths Mentor online drop ins and
the SmartThinking 24 hour writing feedback service at this link. If you would prefer some more
in depth and tailored support, make an appointment online with a Language and Learning
Adviser.

7 Referencing and Academic Integrity

Deakin takes academic integrity very seriously. It is important that you (and if a group task,
your group) complete your own work in every assessment task Any material used in this as-
signment that is not your original work must be acknowledged as such and appropriately ref-
erenced. You can find information about referencing (and avoiding breaching academic in-
tegrity) and other study support resources at the following website: http://www.deakin.edu.
au/students/study-support.

Page 4 of 18
8 Your rights and responsibilities as a student

As a student you have both rights and responsibilities. Please refer to the document Your rights
and responsibilities as a student in the Unit Guide & Information section in the Content area
in the CloudDeakin unit site.

9 Assessment Task 2

The questions in this Written Assignment carry 90 Marks, and the presentation carries 10
Marks, which brings total 100 marks and is converted to equal 40% of your total assessment in
this unit.

Marks have been allocated for each question and it will help you to self-evaluate after
finishing. If you receive 80 marks out of 100 marks, it is equivalent to 32 marks out of 40 marks
and contribute 32 marks to your total assessment in this unit.

The words limit is set for discussion/essay-type question ONLY. You can see these limits as
a guideline for you to answer question. We expect to see succinct answer, the fewer the better.

9.1 Presentation (10 Marks)

To receive full marks of presentation (GLO 2: 10 Marks), you must meet the following criterion:

1. Correct referencing;

2. Well organized layout of report;

3. Figures and plots are clearly and correctly titled and labelled, appropriate scale is applied;

4. Not exceed more than 10% of word limits.

Page 5 of 18
9.2 Part A: Derivative Products from ASX (10 Marks)

Question A1 (Explore the Derivative Products Offered by ASX). Assume

you were working for an investment consulting firm and were assigned a job to give a
presentation to introduce derivative products from ASX to your client.

To prepare your presentation, you need explore the webpage https://www2.asx.

com.au/markets/trade-our-derivatives-market, read and then summarize the key
information. Please note your job here is not simply “copy” and “paste” but rather is to
select and present the information in a way that you expect to meet their expectation.
(Words limit: 700; 10 Marks; GLO 2)

9.3 Part B: Option Basics (20 Marks)

Question B1 requires you to explore https://www2.asx.com.au and pick your own underlying
stock and options. What to note is that not all common stocks have publicly traded options,
as we are studying options, you need select a common stock with associated publicly traded
options. To access the market data, do the following steps:

1. Click link: https://www2.asx.com.au/markets/trade-our-cash-market/directory and

you will see following:

2. Search or scroll down to find your company. For example, if I type “anz” on row “Search
for a company by code or name”, I get the following:

Page 6 of 18
 3. If you see “Options” (circled), click, otherwise, you need select a different company until
you see “Options”.

Please note that market data are updated constantly. Even if you choose the same underling
stock, given that you are not likely to access the data at the same time, you will see different
prices. It is very important to access these information during normal business time,
otherwise you will see all “0”, you need have valid data to complete the current
assignment!!

It might be your first experience to read market data from ASX. To help you understand
basic information, consider the following screen-shot (Figure 1). The information was retrieved
at 11:10AM on 21th Feb, 2023 when the last-trade-price of ANZ (ANZ Group Holdings Limited)
common shares was recorded as $24.530 per share.

Page 7 of 18
 Figure 1: Example used for data explanation: March Calls & Puts on ANZ

The screen-shot contains both American (STYLE (A)) and European (STYLE (E)) types
of calls and puts. As any security traded in an Exchange, each security has a “BID” which is
the price you get if you sell the security (i.e., the option) and a “OFFER” which is the price you
pay if you buy the security. From a trader’s perspective, bid and offer prices are the prices you
should focus. “LAST TRADE” records the last-trade-price, it might not necessarily be between
current bid and offer prices as bid and offer quotes are updated constantly. If market is not
liquid/active, by the time you read the data, a significant amount of time may have elapsed since
the last trade actually conducted. The information in the rest of columns is straightforward.

Question B offers you an opportunity to review option basics using market data and find
some patterns embedded in these prices. To collect the data for completing the question, you
do the following steps:

Page 8 of 18
1. Choose a particular underlying stock given your specific interest and view.

2. Choose one particular time-to-expiry between one to nine months (e.g., a month to expiry
in the above example).

3. Choose Both European and American type of calls and puts.

4. If the options are very active, you will find a long list of strike prices. Choose thirteen
different strike prices spread between a level of St × (1 − 30%) and St × (1 + 30%) where
St is last-trade-price of underlying common shares.

ˆ For example, if St = 24.53, you choose strike prices range between $17.171(= 24.53 ×
0.7) and $31.889 = (24.53 × 1.3);
ˆ You need access data during, say 10:00AM - 16:00PM Monday to Friday, none public
holiday;
ˆ You need both non-zero bid and offer prices so as to complete the question. Change
the underlying or time-to-expiry until you find the dataset meet the requirements.

Question B (Intrinsic Value and Time Value). Once you have collected your data
(i.e., European Call and Put; American Call and Put, properly present your raw data
and record option intrinsic value and time value. For example, you use the following
table template:

Option: European Calls

Underlyings: XXX
Current stock price:$$$
Strike Price Intrinsic Value Time Value
K1
K2
..
.
K13

Table 1: Template(Question B)

It might be helpful if you can visualize your data, e.g., plot these different values against
strike prices. Look at these data (in either table or plot or both), describe your observa-
tions and comment on any pattern or abnormal that you have identified. (Words limit:
500; 20 Marks; GLO 1+ GLO 4)

Page 9 of 18
9.4 Part C: Option Strategies (35 Marks)

Call buying is the simplest form of investment in option market, therefore is the most frequently
used option “strategy” by the public investors. The success of a call buying depends primarily
on one’s ability to select stocks that will go up by time of option expiration.

By now you must be more comfortable to deal with calls. The motivation for call buying
may be different, but one must be bullish on the underlying stock in order to consider buying
calls on that stock. Once the underlying stock has been selected, the call buyers then begin to
consider other factors, such as which strike price to use and which expiration to buy.

One important piece of information associated with options is “delta” (∆) which tells you
how much of an increase or decrease can be expected for instant moves of the underlying stock.
For call buying, this piece of information may help the buyer to decide which call to buy.

The issue with delta is that it changes each time the underlying stock changes as we have seen
in binomial tree model 1 . It will make analysis easier by taking a slightly incorrect, assuming
that the delta remains constant over a short period of time. To estimate option delta, we can
use Black-Sholes formula. Recall the Black-Sholes formula for a European call option is:

c = S0 N (d1 ) − Ke−rT N (d2 )

where 2
ln SK0 + (r + σ2 )T
d1 = √
σ T
√
d2 = d1 − σ T

Given the definition of “Delta”, we have

Detla = ∆ = N (d1 )

We use the data from Figure 2 to answer questions in Part C.

1
One important measure to tell you how sensitive of delta to underlying stock changes is named “gamma”
(γ).

Page 10 of 18
 Figure 2: Data for Part C

To use above formula to (approximately) calculate option delta, we need information on

risk-free interest rate and volatility of underlying asset. We assume a flat interest rate 3.5% per
annum continuous compounding. You need compute volatility using the methodology presented
in lecture slides Topic 6. The historical ANZ common share prices can be downloaded from the
following link: https://au.finance.yahoo.com/quote/ANZ.AX/history/.

Choose the “Time period” and “Frequency” and download the dataset. The price used to
do the historical volatility calculation is “Adj. close** ”. Once you have volatility ready, you are
ready to answer Question C1.

Click the link you will see the following:

Page 11 of 18
Question C1 (Investing in Call). We use the data in Figure 2 to answer this
question and the data were retrieved at 11:40 AM on 21th Feb, 2023. Figure 2 gives 12
American call options on ANZ, expiration date is 20th April,2023. The current stock
price S0 = $24.53.

Which call is the better buy if you expect ANZ common shares to quickly rise to $28
per share? You need elaborate on your analysis. (Words limit: 200; 20 Marks; GLO 1 +
GLO 5)

Page 12 of 18
 To answer Question C2, assume that you have bought calls, when price of ANZ common
shares drops, the simplest response that you can give is to sell your calls so as to cut your losses.
On the contrary, when stock price rises, you would like to take or secure your profit. In general,
there are four strategies as a follow-up response for increasing stock price (call them “follow-up
actions”):

1. “Do nothing”. You can continue to hold existing calls.

2. “Liquidate”. You can sell the calls (close your position) to take profits. Given that you
have to pay commissions by trading stocks, it is rarely to your benefit to exercise the call.

3. “Roll up”. You sell the calls you are holding, pocket the original investment, and use the
remaining proceeds to purchase out-of-the-money calls.

4. “Spread”. You sell out-of-the-money call against your current call to create a bull spread.
You wish the selling premium could cover at least some original cost of the long call.

Page 13 of 18
Question C2 (Monitoring Your Position). Let’s use the following information for
Question C2. Assume that you have bought ANZDW8 (American call, expires 20th April,
2023) some time ago when the common share price was $24.53, the strike price of the call
is $25 and each call costs you $0.55 (column 1). The 2nd column gives data for today’s
information which are self-explainable given you are taking this unit.

Original Trade Current Prices

ANZ Common: 24.53 ANZ Common: 26
Bought CBA Apr 25: 0.55 ANZ Apr 25: 1.53
ANZ Apr 27: 0.40

Table 2: Updated Market (Question C2)

Each of above four follow-up actions would produce different levels of risk and reward
from today onwards. Use the following table as a template to compare these alterna-
tive strategies at expiration and label the best and worst strategies for each scenario.
Comment on your analysis results. (Words limit: 300; 15 Marks; GLO 1+ GLO 5)

ANZ Price “Do nothing” “Liquidate” “Roll up” “Spread”

Expiration Profit Profit Profit Profit
23 or below
23.5
24
24.5
25
25.5
26
26.5
27
27.5
28
28.5
29

Table 3: Strategy Comparing (Question C2)

Page 14 of 18
9.5 Part D: Implied Volatility (25 Marks)

You will need to use Goal Seek... in EXCEL to find a put option’s implied volatility. Here
we’ll use EXCEL spreadsheet “MAF308 Puts Dvd.xlsx”.

Figure 3: Data for Part D

Figure 3 gives 12 American put options on ANZ, expiration date is 20th April,2023. The
current stock price S0 = $24.57. Your are required to find implies volatility for these option data.
As an example, assume you want to find implied volatility associated with option ANZDT8.
The information you need are as following:

1. The price of ANZDT8. What we find is that, there are three prices, BID, OFFER and
LAST TRADE. The “∗ ” with LAST TRADE indicate that the price is “theoretical”
price. Depending on task, you would choose one type of price over the alternative one.
For this particular question, you can choose to use “LAST TRADE”. Therefore the price
of ANZDT8 is $0.54.

2. The other inputs you need are, current stock price S0 = $24.57, expiration date is 20th
April, 2023; the strike price is $24.5.

3. We need risk-free interest rate, we assume 3.5% per annum, continuously compounding,

Page 15 of 18
 which is slightly higher than current cash rate.

4. Settlement date is 21th Feb, 2023 when these option prices are observed. To get correct
implied volatility, you need fix this settlement date.

5. Dividend payment. My finding is that though ANZ pays semi-annual dividend, there is
no dividend payment during the duration of the chosen option contracts. You need verify
this information and correct it if needed.

We have all information used to pricing option except Sigma (σ). Instead, now we have
price but Sigma is unknown. Before use “MAF308 Puts Dvd.xlsx” to find implied volatility,
spend some time to understand the information presented in the spreadsheet. The spread sheet
contains both Binomial tree model and Black-Schole formula.

Once you are family with the spreadsheet, and input all the data required, we can use it to
solve for sigma. This is done using Goal Seek..., as follows:

1. Click “Data” and find Goal Seek...

2. For “Set cell”, enter the cell containing the American put option price, C20 (or click cell
C20 in the spreadsheet).

3. Next “To value” enter the put option price 0.54 (read from Figure 3).

Page 16 of 18
4. By changing cells: enter the cell containing the value of sigma, E5, and click “OK”.

Cell E5 in your spreadsheet will now contain the implied volatility for this option.

Page 17 of 18
Question D1 (Implied Volatility). We have found that the implied volatility
for the American option ANZDT8 is approximate 0.1597. If all the terms are same
except it was a European option, will the inferred volatility be the same, higher or
lower? Give your reasoning. (Words limit: 300; 10 Marks; GLO 1 + GLO 4)

Question D2 (Volatility Smile). Repeat the above procedure for all put op-
tions listed in Figure 3. Compare the implied volatilities (you have 12 implied
volatilities) and comment on your findings. (Words limit: 500; 15 Marks; GLO 1+
GLO 4)

====== The End ======

Page 18 of 18