‘‘An option adjusted spread is analogous to the yield on a bond.’’ Explain this statement.
> Suppose that in a one-factor Gaussian copula model the 5-year probability of default for each of 125 names is 3% and the pairwise copula correlation is 0.2. Calculate, for factor values of -2, -1, 0, 1, and 2: (a) the default probability conditional on
> A security’s price is positively dependent on two variables: the price of copper and the yen/dollar exchange rate. Suppose that the market price of risk for these variables is 0.5 and 0.1, respectively. If the price of copper were held fixed, the volati
> ‘‘The position of a buyer of a credit default swap is similar to the position of someone who is long a risk-free bond and short a corporate bond.’’ Explain this statement.
> Explain how forward contracts and options on credit default swaps are structured.
> Verify that, if the CDS spread for the example in Tables 25.1 to 25.4 is 100 basis points, the hazard rate must be 1.63% per year. How does the hazard rate change when the recovery rate is 20% instead of 40%? Verify that your answer is consistent with th
> Show that the spread for a new plain vanilla CDS should be times the spread for a similar new binary CDS, where R is the recovery rate.
> How does a 5-year nth-to-default credit default swap work? Consider a basket of 100 reference entities where each reference entity has a probability of defaulting in each year of 1%. As the default correlation between the reference entities increases wha
> What is the credit default swap spread in Problem 25.8 if it is a binary CDS? Data from Problem 25.8: Suppose that the risk-free zero curve is flat at 7% per annum with continuous compounding and that defaults can occur halfway through each year in a n
> Explain the difference between the Gaussian copula model for the time to default and CreditMetrics as far as the following are concerned: (a) the definition of a credit loss and (b) the way in which default correlation is modeled.
> Verify (a) that the numbers in the second column of Table 24.3 are consistent with the numbers in Table 24.1 and (b) that the numbers in the fourth column of Table 24.4 are consistent with the numbers in Table 24.3 and a recovery rate of 40%. Tabl
> ‘‘A long forward contract subject to credit risk is a combination of a short position in a no-default put and a long position in a call subject to credit risk.’’ Explain this statement.
> A company has issued 3- and 5-year bonds with a coupon of 4% per annum payable annually. The yields on the bonds (expressed with continuous compounding) are 4.5% and 4.75%, respectively. Risk-free rates are 3.5% with continuous compounding for all maturi
> In an annual-pay cap, the Black volatilities for at-the-money caplets which start in 1, 2, 3, and 5 years and end 1 year later are 18%, 20%, 22%, and 20%, respectively. Estimate the volatility of a 1-year forward rate in the LIBOR Market Model when the t
> Give an example of (a) right-way risk and (b) wrong-way risk.
> A 4-year corporate bond provides a coupon of 4% per year payable semiannually and has a yield of 5% expressed with continuous compounding. The risk-free yield curve is flat at 3% with continuous compounding. Assume that defaults can take place at the end
> Show that the value of a coupon-bearing corporate bond is the sum of the values of its constituent zero-coupon bonds when the amount claimed in the event of default is the no-default value of the bond, but that this is not so when the claim amount is the
> Suppose that in an asset swap B is the market price of the bond per dollar of principal, is the default-free value of the bond per dollar of principal, and V is the present value of the asset swap spread per dollar of principal. Show that .
> Does put–call parity hold when there is default risk? Explain your answer.
> ‘‘When a bank is negotiating currency swaps, it should try to ensure that it is receiving the lower interest rate currency from companies with low credit risk.’’ Explain why.
> Explain why the impact of credit risk on a matched pair of interest rate swaps tends to be less than that on a matched pair of currency swaps.
> Suppose that the LIBOR/swap curve is flat at 6% with continuous compounding and a 5-year bond with a coupon of 5% (paid semiannually) sells for 90.00. How would an asset swap on the bond be structured? What is the asset swap spread that would be calculat
> At the end of Section 23.8, the VaR and ES for the four-index example were calculated using the model-building approach. How do the VaR and ES estimates change if the investment is $2.5 million in each index? Carry out calculations when (a) volatilities
> Show that the GARCH (1,1) model 1in equation (23.9) is equivalent to the stochastic volatility model , where time is measured in days, V is the square of the volatility of the asset price, and What is the stochastic volatility model when time is measured
> The payoff from a derivative will occur in 8 years. It will equal the average of the 1-year risk-free interest rates observed at times 5, 6, 7, and 8 years applied to a principal of $1,000. The risk-free yield curve is flat at 6% with annual compounding
> Suppose that in Problem 23.12 the correlation between the S&P 500 Index (measured in dollars) and the FTSE 100 Index (measured in sterling) is 0.7, the correlation between the S&P 500 Index (measured in dollars) and the dollar/sterling exchange rate is 0
> Suppose that the daily volatility of the FTSE 100 stock index (measured in pounds sterling) is 1.8% and the daily volatility of the dollar/sterling exchange rate is 0.9%. Suppose further that the correlation between the FTSE 100 and the dollar/sterling e
> Suppose that the current daily volatilities of asset X and asset Y are 1.0% and 1.2%, respectively. The prices of the assets at close of trading yesterday were $30 and $50 and the estimate of the coefficient of correlation between the returns on the two
> The parameters of a GARCH(1,1) model are estimated as , , and. What is the long-run average volatility and what is the equation describing the way that the variance rate reverts to its long-run average? If the current volatility is 20% per year, what
> Suppose that the daily volatilities of asset A and asset B, calculated at the close of trading yesterday, are 1.6% and 2.5%, respectively. The prices of the assets at close of trading yesterday were $20 and $40 and the estimate of the coefficient of corr
> ‘‘DVA can improve the bottom line when a bank is experiencing financial difficulties.’’ Explain why this statement is true.
> Describe how netting works. A bank already has one transaction with a counterparty on its books. Explain why a new transaction by a bank with a counterparty can have the effect of increasing or reducing the bank’s credit exposure to the counterparty.
> A driver entering into a car lease agreement can obtain the right to buy the car in 4 years for $10,000. The current value of the car is $30,000. The value of the car, S, is expected to follow the process where , , and dz is a Wiener process. The ma
> Show that if y is a commodity’s convenience yield and u is its storage cost, the commodity’s growth rate in the traditional risk-neutral world is r − y + u, where r is the risk-free rate. Deduce the relationship between the market price of risk of the co
> The market price of risk for copper is 0.5, the volatility of copper prices is 20% per annum, the spot price is 80 cents per pound, and the 6-month futures price is 75 cents per pound. What is the expected percentage growth rate in copper prices over the
> Suppose that the payoff from a derivative will occur in 10 years and will equal the 3-year U.S. dollar swap rate for a semiannual-pay swap observed at that time applied to a certain principal. Assume that the swap yield curve is flat at 8% (semiannually
> Explain the difference between the net present value approach and the risk-neutral valuation approach for valuing a new capital investment opportunity. What are the advantages of the risk-neutral valuation approach for valuing real options?
> Suppose that you have 50 years of temperature data at your disposal. Explain carefully the analyses you would carry out to value a forward contract on the cumulative CDD for a particular month.
> Distinguish between the historical data and the risk-neutral approach to valuing a derivative. Under what circumstance do they give the same answer?
> Consider two bonds that have the same coupon, time to maturity, and price. One is a B-rated corporate bond. The other is a CAT bond. An analysis based on historical data shows that the expected losses on the two bonds as a function of time are the same.
> Explain how CAT bonds work.
> Explain how a option contract for May 2017 on electricity with daily exercise works. Explain how a option contract for May 2017 on electricity with monthly exercise works. Which is worth more?
> In the accrual swap discussed in the text, the fixed side accrues only when the floating reference rate lies below a certain level. Discuss how the analysis can be extended to cope with a situation where the fixed side accrues only when the floating refe
> Calculate the total convexity/timing adjustment in Example 34.3 of Section 34.4 if all cap volatilities are 18% instead of 20% and volatilities for all options on 5-year swaps are 13% instead of 15%. What should the 5-year swap rate in 3 yearsâ
> Calculate all the fixed cash flows and their exact timing for the swap in Business Snapshot 34.1. Assume that the day count conventions are applied using target payment dates rather than actual payment dates. Business Snapshot 34.1 Hypothetical Conf
> Explain why a sticky cap is more expensive than a similar ratchet cap.
> Suppose that the risk-free yield curve is flat at 8% (with continuous compounding). The payoff from a derivative occurs in 4 years. It is equal to the 5-year rate minus the 2-year rate at this time, applied to a principal of $100 with both rates being co
> Provide an intuitive explanation of why a ratchet cap increases in value as the number of factors increase.
> ‘‘When the forward rate volatility, , in HJM is , the Hull–White model results.’’ Verify that this is true by showing that HJM gives a process for bond prices that is consistent with the Hull–White model in Chapter 32.
> ‘‘When the forward rate volatility in HJM is constant, the Ho–Lee model results.’’ Verify that this is true by showing that HJM gives a process for bond prices that is consistent with the Ho–Lee model in Chapter 32.
> Suppose a = 0:05, , and the term structure is flat at 10%. Construct a trinomial tree for the Hull–White model where there are two-time steps, each 1 year in length.
> Suppose that a = 0:05 and in the Hull–White model with the initial term structure being flat at 6% with semiannual compounding. Calculate the price of a2.1-year European call option on a bond that will mature in 3 years. Suppose that the bond pays a cou
> Suppose that a =0:05, b =0:08, and in Vasicek’s model with the initial shortterm interest rate being 6%. Calculate the price of a 2.1-year European call option on a bond that will mature in 3 years. Suppose that the bond pays a coupon of 5% semiannually
> Repeat Problem 32.3 valuing a European put option with a strike of $87. What is the put–call parity relationship between the prices of European call and put options? Show that the put and call option prices satisfy put–
> Calculate the price of an 18-month zero-coupon bond from the tree in Figure 32.8 and verify that it agrees with the initial term structure. Figure 32.8 Tree for lognormal model. Node: A в с B E н D F H I -3.373 -2.875 -3.181 -3.487 -2.430 -2.736 -3.
> Calculate the price of a 2-year zero-coupon bond from the tree in Figure 32.7 and verify that it agrees with the initial term structure. Figure 32.7 Tree for R in Hull-White model (the second stage). H A Node: A B D E F G H I R (%) 3.824 6.937 5.205
> Consider an instrument that will pay off S dollars in 2 years, where S is the value of the Nikkei index. The index is currently 20,000. The yen/dollar exchange rate is 100 (yen per dollar). The correlation between the exchange rate and the index is 0.3 a
> Explain the exponentially weighted moving average (EWMA) model for estimating volatility from historical data.
> Agriculture is one of the largest and oldest industries in the world. In the United States and many other countries, farmers often struggle to turn a profit given the variances of weather and commodity prices. Some working farms are turning to tourism as
> Your group works for Warner Music Group (www .wmg.com), a large music record label whose sales are declining largely due to digital piracy. Your supervisor assigns you the task of developing a strategy for improving this situation. 1. What are the key
> Ryanair based in Dublin, Ireland, has been renowned in Europe as a firm that can make a profit on a $20 ticket by imposing numerous fees and surcharges. The airline has sought to be the lowest of the low-cost providers in the EU with a “no frills get you
> In the discussion about Merck (Strategy Highlight 2.1), it is clear the firm has followed a socially responsible path by donating more than 1 billion drug treatments to remedy river blindness in remote African communities. Yet Merck must also meet shareh
> The MBA oath (shown in Exhibit 12.4) says in part, “My decisions affect the well-being of individuals inside and outside my enterprise, today and tomorrow.” One example of a large firm reorienting toward this approach is PepsiCo. In the last few years, P
> As noted in the chapter, the average compensation for a CEO of a Fortune 500 company was $14 million, and CEO pay was 300 times the average worker pay. This contrasts with historic values of between 25 and 40 times the average pay. In August 2015 the U.S
> Assume you work in the accounting department of a large software company. Toward the end of December, your supervisor tells you to change the dates on several executive stock option grants from March 15 to July 30. Why would she ask for this change? What
> A “race-to-the-bottom” process may set in as MNEs search for ever-lower-cost locations. Discuss the trade-offs between the positive effects of raising the standard of living in some of the world’s poorest countries with the drawbacks of moving jobs estab
> Alliances and acquisitions can sometimes lead to less access or higher prices for consumers. Comcast bought NBC Universal (from GE). When one content provider and the Internet access provider are the same, will this lead to some content being favored ove
> If mergers and acquisitions quite often end up providing a competitive disadvantage, why do so many of them take place? Given the poor track record, is the continuing M&A activity a result of principal– agent problems and managerial hubris? What can be d
> The chapter notes that some firms choose to outsource their human resource management systems. If a firm has a core value of respecting its employees and rewarding top performance with training, raises, and promotions, does outsourcing HR management show
> What is a strategic group? How can studying such groups be useful in industry analysis?
> GE’s development of the Vscan provides many benefits as a lower-cost and portable ultrasound device (see Strategy Highlight 7.2). Cardiologists, obstetricians, and veterinarians will be able to use the device in rural areas and developing countries. One
> You are a co-founder of a start-up firm making electronic sensors. After a year of sales, your business is not growing rapidly, but you have some steady customers keeping the business afloat. A major supplier has informed you it can no longer supply your
> In the chapter discussion on value innovation, IKEA is noted as a firm that has successfully applied these techniques. What roles, if any, do sustainability and triple-bottom-line factors have in the success of IKEA as a leader in the furniture industry?
> Suppose Procter & Gamble (P&G) learns that a relatively new start-up company Method (www .methodhome.com) is gaining market share with a new laundry detergent in West Coast markets. In response, P&G lowers the price of its Tide detergent from $18 to $9 f
> How do the perspectives on competitive advantage differ when comparing brick-and-mortar stores to online businesses (e.g., Best Buy vs. Amazon, Barnes & Noble vs. Amazon, The Gap vs. Thread less (noted in Strategy Highlight 1.1), Nordstrom vs. Zappos, an
> The chapter mentions that accounting data do not consider off–balance sheet items. A retailer that owns its stores will list the value of that property as an asset, for example, while a firm that leases its stores will not. What are some of the accountin
> You work as a supervisor in a manufacturing firm. The company has implemented a balanced scorecard performance-appraisal system and a financial bonus for exceeding goals. A major customer order for 1,000 units needs to ship to a destination across the co
> The chapter mentions that one type of resource flow is the loss of key personnel who move to another firm. Assume that the human resources department of your firm has started running ads and billboards for open positions near the office of your top compe
> The chapter notes the U.S. federal government has provided incentives for consumers to purchase electric vehicles (EVs). Some state governments are also providing additional purchase incentives. However, other countries are also encouraging the purchase
> UBS, a venerable Swiss banking institution with global business activities, experienced the significant implications that political factors can have on the bottom line. The U.S. government alleged that by advertising its “tax savings” advantages to U.S.
> How do the five competitive forces in Porter’s model affect the average profitability of the industry? For example, in what way might weak forces increase industry profits, and in what way do strong forces reduce industry profits? Identify an industry in
> The list below shows a sample of various vision/ mission statements. Match the company with their statements. Also, identify whether the statements are principally customer-oriented or product-oriented. Type of Matched Vision/Mission Statement Statem
> Corporate leaders are responsible for setting the firm’s strategies to gain and sustain a competitive advantage. Should managers be concerned only about the company’s financial performance? What responsibility do company managers have for other consequen
> The chapter highlights several firms that are developing business models around a “sharing economy.” The idea being that assets not currently in use by their owners (cars, car seats, homes, rooms, etc.) can be rented to (shared with) others. What other i
> Interface, Inc., is discussed in Strategy Highlight 5.1. It may seem unusual for a business-to-business carpet company to be using a triple-bottom-line approach for its strategy. What other industries do you think could productively use this approach?
> For many people, the shareholder perspective is perhaps the most familiar measure of competitive advantage for publicly traded firms. What are some of the disadvantages of using shareholder value as the sole point of view for defining competitive advanta
> Domino’s Pizza has been in business over 50 years and claimed to be “#1 Worldwide in Pizza Delivery” in 2013. Visit the company’s business-related website (www.dominosbiz.com) and read the company profile under the “Investors” tab. Does the firm focus on
> Much has been said about competitive advantage gained from innovations such as the Internet, high-technology gadgets, and apps. The chapter points out, however, that low-technology innovations such as the razor–razorblade business model can also create v
> The chapter discussed the Internet as a disruptive innovation that has facilitated online retailing. It also, however, has presented challenges to brick and- mortar retailers. How might retailers such as Nordstrom, Neiman Marcus, or Macy’s need to change
> Describe a firm you think has been highly innovative. Which of the four types of innovation—radical, incremental, disruptive, or architectural—did it use? Did the firm use different types over time?
> Select an industry and consider how the industry life cycle has affected business strategy forthe firms in that industry over time. Detail your answer based on each stage: introduction, growth, shakeout, maturity, and decline.
> How do mobility barriers affect the structure of an industry? How do they help us explain firm differences in performance?
> As noted in the chapter, research found that firm effects are more important than industry effects. What does this mean? Can you think of situations where this might not be true? Explain.
> BP’s experience in the Gulf of Mexico has made it the poster company for how not to manage stakeholder relationships effectively (see Strategy Highlight 1.2). What advice would you give to BP’s managers to help them continue to rebuild stakeholder relati
> The Business Roundtable has recommended that the CEO should not also serve as the chairman of the board. Discuss the disadvantages for building a sustainable competitive advantage if the two positions are held by one person. What are the disadvantages fo
> How can a top management team lower the chances that key managers will pursue their own self-interests at the expense of stockholders? At the expense of the employees? At the expense of other key stakeholders?
> The resource-based view of the firm identifies four criteria that managers can use to evaluate whether particular resources and capabilities are core competencies and can, therefore, provide a basis for sustainable competitive advantage. Are these measur
> Why is it important to study the internal resources, capabilities, and activities of firms? What insights can be gained?
> Professor Pankaj Ghemawat delivered a TED talk titled “Actually, the World Isn’t Flat.” Do you agree with his assessment that the world is at most semi-globalized, and that we need to be careful not to fall victim to “globalony”? View the talk at: www.te
> Multinational enterprises (MNEs) have an impact far beyond their firm boundaries. Assume you are working for a small firm that supplies a product or service to an MNE. How might your relationship change as the MNE moves from Globalization 2.0 to Globaliz
> The chapter notes there are key differences between economies of scale and learning effects. Let us put that into practice with a brief example. A company such as Intel has a complex design and manufacturing process. For instance, one fabrication line fo
