DERIVATIVES AND RISK MANAGEMENT Assume that you have just been hired as a financial analyst and consultant by Spy Family Inc., a mid-sized Texas company that specializes in creating high-fashion clothing. Because no one at Spy Family is familiar with the basics of financial options, you have been asked to prepare a brief report that the firm's executives can use to gain at least a cursory understanding of the topic. To begin, you gathered some outside materials on the subject and used these materials to draft a list of pertinent questions that need to be answered. In fact, one possible approach to the report is to use a question-and-answer format. Now that the questions have been drafted, you have to develop the answers. 1. What are financial options? 2. What are the two primary types of financial options? 3. What is a call option's exercise value? 4. What is the Black-Scholes option pricing model (OPM) the binomial model? 5. What are the five inputs to the Black-Scholes model? 6. What does the formula for put-call parity relationship state? 7. Consider Spy Family's call option with a $25 strike price. The following ta
CHAPTER 6. DERIVATIVES AND RISK MANAGEMENT Assume that you have just been hired as a financial analyst and consultant by Spy Family Inc., a mid-sized Texas company that specializes in creating high-fashion clothing. Because no one at Spy Family is familiar with the basics of financial options, you have been asked to prepare a brief report that the firm's executives can use to gain at least a cursory understanding of the topic. To begin, you gathered some outside materials on the subject and used these materials to draft a list of pertinent questions that need to be answered. In fact, one possible approach to the report is to use a question-and-answer format. Now that the questions have been drafted, you have to develop the answers. 1. What are financial options? 2. What are the two primary types of financial options? 3. What is a call option's exercise value? 4. What is the Black-Scholes option pricing model (OPM) the binomial model? 5. What are the five inputs to the Black-Scholes model? 6. What does the formula for put-call parity relationship state? 7. Consider Spy Family's call option with a $25 strike price. The following table contains historical values for this option at different stock prices: Stock Price Call Option Price $25 $3.00 30 35 40 7.50 12.00 16.50 45 50 or 21.00 25.50 a. Create a table that shows (a) stock price, (b) strike price, (c) exercise value, (d) option price, and (e) the time value, which is the option's price less its exercise value. b. What happens to the time value as the stock price rises? Why?.
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