wht is ur problem guys?
...f the option will move so that the option becomes more valuable. These parameters can be summarised as: the quantity of the difference between the strike price the market value of the underlying asset the time left until expiry of the option the short-term risk-free borrowing rate the volatility of the underlying asset. The calculation of the value of these parameters is quite complex, and historic events and probabilities determine some parameters. The effect of these parameters will briefly be discussed. a. The quantity of the difference between the strike price and the market value If the market value of an underlying instrument is far from the strike price, the likelihood of the option becoming at-the-money is less. A call option, for instance, where the market value is far below the strike price, is said to be deep-out-of-the-money. The probability of this option moving in-the-money or at-the-money is less than for a call option where the strike price and the market value is close together (assuming the same underlying instrument). The risk to the writer is more where the two prices are close together, and this risk will be discounted in the price of the option. b. The time left to expiry The more time there is left to the expiry of the option contract, the more uncertainty there is concerning the movement of the market value of the underlying asset. This increases the risk, and the writer of the option has to be compensated for this risk (remember that derivatives is about selling risks!). The time value of the option, however, does not decrease over a straight line. During the last few days before expiry, the time value decreases faster, as there is less uncertainty about the probable market value of the underlying asset at expiry. c. The short-term risk-free borrowing rate The writer of a call option must buy the underlying instrument and carry (hold) this instrument to expiry if he wants to hedge his risk in writing the option. To buy the instrument it is assumed that he either borrows the money at the short-term risk-free interest rate, or uses internal funds that will cost him the cost of capital from his business. The writer must thus be compensated for the cost of carrying the asset, and this cost will be incorporated in the price of the option. d. The volatility of the underlying asset The volatility of an asset is a measure of risk involved in an asset due to price fluctuations of that asset. In general, the more the price of an asset is likely to fluctuate, the more volatile the asset. Volatility can only be measured by using historic values. Historic fluctuations of the price of an asset are thus used to determine a value for the volatility to be used as a parameter in deciding the price of an option. The market as a whole can sometimes be more volatile than at other times. In times of high volatility in the markets, options tend to be more expensive than in times of low volatility. (Increase or decrease in any 3 det. individually or the 3 together?) 2. a. Swap agreement on interest rate: Interest rate swaps are the most important type of swap in terms of volume of transactions. An interest rate swap is an agreement between two counterparties to exchange fixed interest rate payment for floating interest rate payments in the same currency calculated with reference to an agreed notional amount of principal (hence the alternative name contract for differences). The principal amount, which is equivalent to the value of the underlying assets or liabilities that are swapped, is never physically exchanged but is used merely to calculate interest payments. The purpose of the swap is to transform a fixed rate liability into a floating rate liability and vice-versa where the floating rate used is calculated in reference to LIBOR. Currency swaps are agreements to exchange payments in one currency for those in another. Sometimes the principal is exchanged as well as the interest payments. The structure of a currency swap is similar to a forward contract or a future contract in a foreign exchange. There are two types of currency swap: fixed rate currency swap and currency coupon swap. Most currency swap involve the US$ on one side of the transaction, but direct currency combination such as euro-yen are also important. Many euro bonds are now issued in unusual currencies such as the Australian $, New Zealand $ etc. solely for the purpose of being swapped into a major currency. 2. b 3. a A Loanable funds framework is used for conducting the analysis for determining the Eurocurrency interest rates. Lets imagine for easiness, a world with n currencies and n financial centers. Lets start with one currency, say the US$, and two financial centres say New York and London. In the onshore market the demand of ...