Posted: October 29th, 2022

Financial Derivatives – Questions

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)

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

b) Determine the intrinsic values at expiration of a European call option with an exercise price of SAR 45. (1.5 Marks)

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

d) Calculate the hedge ratio. (1 Mark)

Q-2. Explain the concept of moneyness? (3 Marks)

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

(2 Marks)

Answers:

1-

2-

3-

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Q-4 Derivatives are used to manage financial risk. Do you agree? (100-150 Words)

You are required to reply to at least two peer answers. These post replies must need to be substantial and constructive. (40-60 Words per response)

Peer answer 1: All participants in the financial market find that financial derivatives are useful tools for risk management, and they are used by three types of market participants: commercial banks, investment banks, and investors. Easy to understand and that can create credit risk and so must be understood Complex derivations depend on complex models to use which leads to the risk of this chosen model There are credit rating agencies explaining this complexity to investors but their rating can be misunderstood and as a result, may create several risks
It appears that finding a variety of derivative products may be useful for their own risk management purposes and there are several ways and strategies for using a financial derivative can be beneficial for risk management. At the same time, derivatives present some significant challenges to risk management.

Response 1: –

Peer answer 2: Derivatives are most commonly exchanged to decrease risk or to bet on increasing risk in order to make a profit, and their value is determined by the quantity demanded for the asset (Chance & Brooks 2015). If an investor with sterling accounts wished to buy shares in a firm with dollars, they would indeed be subjected to exchange rate risk because the value of the pound could fall or grow against the dollar over the investment term, influencing the value of their investment. To avoid this danger, the investor could purchase a currency derivative to lock in a set exchange rate and protect their funds.

Response 2: –

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