Exam 2 Review

1
Exam 2 Review

• Formulas will be provided
• Bring a calculator
• Short-answer / problem questions
• See practice questions

2
Question Breakdown

• Capital Market Theory 3 questions
• How do we get to the CML?
• What does the CML tell us?
• CAPM and Alternatives 3 questions
• CAPM box
• Options 3 Questions
• Payoffs
• Futures 2 Questions

3
Review Concepts

• Capital Market Theory
• Risk free asset
• What happens?
• Borrowing vs. Lending
• CML
• What is the market portfolio?
• What does CML tell us?
• Two fund separation
• Separation theorem
• Slope of the capital market line

4
Review Concepts

• CAPM and Alternatives
• How do we get to CAPM from CML
• What is the CAPM and how do we use it
• Calculations
• Interpretation of overvalued vs. undervalued
  according to CAPM
• Whats wrong with the CAPM?
• What alternatives are there to the CAPM?

5
Review Concepts

• Options
• Payoffs
• Lower and Upper bounds
• Put/Call Parity
• Pricing
• Binomial
• Black-Scholes
• American options with dividends

6
Review Concepts

• Futures
• Margins
• Price changes
• Pricing financial contracts
• Differences in pricing with commodities

7
We have the following information 30-day Yen
.008993, Spot Yen .008973, rus .0825, rj
.01625. F Se(r - rf)(T-t) .008993 ?
.008973e(.0825-.01625)(30/360) .008993 ?
.009023 Strategy Buy low, sell high
8

• Suppose that we have the following information
  taken from the Wall Street Journal Future
  British Pound 1.6390 , Spot Pound 1.6364, rus
  .0625, rgb .04. Suppose you can borrow and
  lend at these rates. Do any arbitrage
  opportunities exist? If any arbitrage
  opportunities exist, show the transactions (and
  associated payoffs) that you would undertake in
  order to take advantage of the arbitrage
  opportunity. Assume that you want to transact
  1,000,000 and that there are 105 days until the
  futures contract expires.

9
Examples

• Suppose we have a European call option with an
  exercise price of 72 that has 120 days left to
  maturity. The current stock price is 74 and the
  annual, continuously compounded risk-free rate is
  .06. If the current price of the call option is
  6.25 the current price of a put contract with
  the exact same specifications must be ..

10
Example

• The following question relates to combining
  options. Assume there are no transaction costs.
  Suppose that I am long in a call option with an
  exercise price of 50, write a call option with an
  exercise price of 54, and am long in a put option
  with an exercise price of 54. The price of the
  X50 call is 6.75, the price of the X54 call is
  4.00, and the cost of the X54 put is 1.75.
  Using the table below as a guide, determine the
  payoffs to the contracts given the stock prices
  listed and determine the net payoff to the
  combination of the three contracts.

11
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12
Suppose that the current price of heating oil is
0.35/gallon. The futures price per gallon of
heating oil for delivery in 30 days is 0.40. I
also know that the initial margin requirement for
heating oil is 7.5 of the total value of my
contract. The maintenance margin is 80 of the
initial margin. If I go short in 50,000 gallons
of the 30 day futures contract, find the initial
and maintenance margins
13
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14
Using the CAPM formulas, assuming the CAPM is
true, and assuming the market variance is .40,
fill in all the blanks. Which securities should
we invest in? Why?