Explore BrainMass

Explore BrainMass

    Five short problems on derivatives, swaps, warrants

    Not what you're looking for? Search our solutions OR ask your own Custom question.

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    Please see the attached files.
    1. Coffman & Tony Inc. can borrow at 13 percent in the long-term capital market (fixed rate) or can borrow at London Interbank offer rate (LIBOR) plus 75 basis points in the Eurodollar market. Jim & Pfeiffenberger Inc. can borrow at 12 percent in the capital market long term (fixed) or can borrow at LIBOR plus 50 basis points. Show a plain vanilla swap arrangement.

    2. Swap/cap/floor parity involves creating a zero cost collar such that cap premium equals the floor premium. You are looking at a $50, non-dividend-paying stock, with a risk-free rate at 5 percent. What strike price would make the one-year call premium equal to the one-year put premium.

    3. A swap dealer notes the following spot interest rates:

    6 months 5.55 percent
    12 months 5.75 percent
    18 months 5.95 percent
    24 months 6.10 percent

    Determine the equilibrium swap price on a semiannual payment, two-year swap.

    4. A speculator buys July corn futures contract at $2.18/bushel and simultaneously writes a July 220 corn futures call option at 8 cents. Calculate the speculator's combined gain or loss if the price of corn rises to 235 and the option is exercised.

    5. One hundred shares of a stock are purchased for $45 per share. Simultaneously, a 5-year warrant on the same company is sold short at $8. The warrant permits the purchase of 100 shares of stock from the company at $55. Over the next 5 years, a total of $2.50 in dividends is received on each share. What is your profit or loss if, at the end of the warrant's life, the stock price is $60.

    © BrainMass Inc. brainmass.com December 15, 2022, 6:56 pm ad1c9bdddf
    https://brainmass.com/business/options/five-short-problems-on-derivatives-swaps-warrants-184714

    Attachments

    Solution Preview

    See the attached file for complete solution. The text here may not be copied correctly.

    1. Coffman & Tony Inc. can borrow at 13 percent in the long-term capital market (fixed rate) or can borrow at London Interbank offer rate (LIBOR) plus 75 basis points in the Eurodollar market. Jim & Pfeiffenberger Inc. can borrow at 12 percent in the capital market long term (fixed) or can borrow at LIBOR plus 50 basis points. Show a plain vanilla swap arrangement.

    In the fixed rate market, Jim & Pfeiffenberger Inc ("J&P") has an advantage of 100 basis points over Coffman & Tony Inc. ("C&T") (12% versus 13%). In the floating rate market, it has an advantage of only 25 bps (Libor + 50 versus Libor + 75). Therefore, J&P has a comparative advantage in the fixed rate market and C&T has a comparative advantage in the floating rate market. So J&P should issue debt at 12% fixed rate and C&T should issue debt at Libor + 75. Let's see now a vanilla swap arrangement that will benefit both parties:

    J&P agrees to pay the Libor (floating) rate to C&T. C&T, on the other hand, agrees to pay a 12% fixed rate to J&P.

    That's a vanilla swap arrangement, and it benefits both parties. J&P receives 12% from C&T (from the swap), and then pays 12% to its creditors (recall we said it issued debt at the fixed rate). It also pays the Libor rate to C&T (from ...

    Solution Summary

    This post explains five problems on Swaps and derivatives. It could be used as a good practice for the students preparing for exams for financial derivatives.

    $2.49

    ADVERTISEMENT