Home Assignment # 6

On Chapter 16

1. What is interest rate risk? Why is it important?

2. What is duration of a bond?
3. A $ 1,000 10% 2 year bond pays semiannual interest. The current yield to maturity 10%. If the yield
to maturity increases to 10.5%, what would be the percentage change in the band’s price?
4. Given that current yield to maturity is 10, find out the duration of the bond.
5. Given the duration of the bond, what should be the approximate change in bond’s price if there is
an increase in interest rate by 50 basis point?
6. How can duration be used to manage a commercial bank?

On Chapter 20

1. Mr. Karim took a long position on a call option on Microsoft at $5 per share. The option will mature
in the month of December, 2017. The strike price of the call option is US$ 55 per share. The current
price of Microsoft in US $56.
a. Is the bond ‘in the money’ or ‘out of the money’?
b. What is the expiration day of the option?
c. If the price of Microsoft on the expiration day turns out to be US$ 58, would the holder of the
option exercise his right?
d. Find out the payoffs and profits from the options at expiration if
ST = US$ 50; ST = US$ 55; ST = US$60; ST = US$ 70
e. At what price of the stock at expiration, the call holder will make no profit and no loss?
f. What would the maximum possible profit and maximum possible loss from the option?
2. What is protective put? Write down the payoffs and profits function at expiration of a protective
put? What is the put premium paid in protective put can be treated as an insurance premium?
3. What is covered call? Write down the payoffs and profits function at expiration of a covered call?
4. An investor took a long position on call position on IBM stock for US $ 8 per stock and a long
position on a put option on the same stock for US$ 4 per stock. The strike price of both the call and
put option is $100 and both will mature on the third Friday of December 2017.
a. Show the payoffs and profits of the position at expiration in a graph.
b. What will be maximum possible profit and loss of the position to the investor.
c. What is the investor’s forecast about future price of IBM stock?