Question: How can a forward contract on a

> Consider three firms identical in all aspects except their monitoring efficiency, which cannot be changed. Even though the cost of monitoring is the same across the three firms, shirkers at Firm A are identified almost for certain; shirkers at Firm B hav

> Suppose a firm’s technology requires it to hire 100 workers regardless of the wage level or market demand conditions. The firm, however, has found that worker productivity is greatly affected by its wage. The historical relationship between the wage leve

> All workers start working for a particular firm when they are 20 years old. The value of each worker’s marginal product is $18 per hour. In order to prevent shirking on the job, a delayed-compensation scheme is imposed. In particular, the wage level at e

> A firm hires two workers to assemble bicycles. The firm values each assembly at $12. Charlie’s marginal cost of allocating effort to the production process is MC = 4N, where N is the number of bicycles assembled per hour. Donna’s marginal cost is MC = 6N

> Taxicab companies in the United States typically own a large number of cabs and licenses; taxicab drivers then pay a daily fee to the owner to lease a cab for the day. In return, the drivers keep all of their fares (so that, in essence, they receive a 10

> Some compensation schemes include a signing bonus while others include the potential to receive annual year-end bonuses. a. From the firm’s perspective, what are the benefits of offering a signing bonus? What are the benefits of offering a year-end bonus

> Economists and psychologists have long wondered how worker effort relates to wages. Specifically, the question is whether worker effort responds to increased wages alone or whether effort also responds to relative wages. a. Design a classroom experiment

> Many public school teachers pay a fixed percentage of their salary into a retirement system. Upon retirement, suppose teachers receive a retirement benefit that depends on their years of service and the salaries they earned during their last two years on

> a. Personal injury lawyers typically do not charge a client unless they obtain a monetary award on their client’s behalf. Why? b. What would happen to the number of lawsuits if lawyers had to charge an hourly rate win or lose and could not charge a fixed

> a. How does the offering of stock options to CEOs attempt to align CEO incentives with shareholder incentives? b. Enron was a company that was ruined in part because of the stock options offered to upper management. Explain. c. In addition to accounting

> a. Why would a firm ever choose to offer profit-sharing to its employees in place of paying piece rates? b. Describe the free-riding problem in a profit-sharing compensation scheme. How might the workers of a firm “solve” the free-riding problem?

> Suppose there are 100 workers in an economy with two firms. All workers are worth $35 per hour to firm A but differ in their productivity at firm B. Worker 1 has a value of marginal product of $1 per hour at firm B, worker 2 has a value of marginal produ

> Several states recently passed laws restricting bargaining rights for public employees. Most notably the changes tended to restrict the union’s right to negotiate over fringe benefits such as health care and retirement benefits. a. What problems were the

> At the competitive wage of $20 per hour, firms A and B both hire 5,000 workers (each working 2,000 hours per year). The elasticity of demand is -2.5 and -0.75 at firms A and B respectively. Workers at both firms then unionize and negotiate a 12 percent w

> Suppose the union’s resistance curve is summarized by the following data. The union’s initial wage demand is $10 per hour. If a strike occurs, the wage demands change as follows: Length of Strike:……………………Hourly Wage Demanded 1 month……………………………………………….$9

> Consider the same setup as in the previous problem, but now the union is allowed to specify any wage, w, and the firm is then allowed to hire as many workers as it wants (up to 225) at the daily wage of w. What wage will the union set in order to maximiz

> Consider a firm that faces a constant per unit price of $1,200 for its output. The firm hires workers, E, from a union at a daily wage of w, to produce output, q, where q = 2 E ½ Given the production function, the marginal product of labor is 1/ E 1/2 .

> A bank has $5 million in capital that it can invest at a 5 percent annual interest rate. A group of 50 workers comes to the bank wishing to borrow the $5 million. Each worker in the group has an outside job available to him or her paying $50,000 per year

> Figure 10-3 demonstrates some of the trade-offs involved when deciding to join a union. a. Provide a graph that shows how the presence of union dues affects the decision to join a union. (Assume all workers pay a flat rate for dues.) Show on your graph h

> Suppose the union in problem 10-1 has a different utility function. In particular, its utility function is given by U = (w - w*) × E where w * is the competitive wage. The marginal utility of a wage increase is still E, but the marginal utility of employ

> Soon after the football season ended in 2011, the National Football League Players Association (NFLPA), which is the union for the players in the National Football League (NFL), and the team owners (the NFL) experienced a labor impasse in the form of a l

> Major League Baseball players are not eligible for arbitration or free-agency until they have been in the league for several years. During these “restricted” years, a player can only negotiate with his current team. Consider a small-market team that happ

> Use a graph to demonstrate the likely bargaining outcomes of three industries, all with identical union resistance curves. a. Firm A has been losing money recently as wages and fringe benefits have risen from 63 to 89 percent of all costs in just the las

> Consider Table 632 in the 2008 U.S. Statistical Abstract. a. Calculate the union wage effect. Calculate the union effect on total benefits. Calculate the union effect on total compensation. b. Note that for nonunion workers, retirement and savings increa

> In Figure 10-7 , the contract curve is PZ. a. Does point P represent the firm or the workers having all of the bargaining power? Does point Z represent the firm or the workers having all of the bargaining power? Explain. b. Suppose the union has the powe

> Suppose the economy consists of a union and a nonunion sector. The labor demand curve in each sector is given by L = 1,000,000 - 20 w. The total (economy wide) supply of labor is 1,000,000, and it does not depend upon the wage. All workers are equally sk

> Suppose the firm’s labor demand curve is given by w = 20 - 0.01E where w is the hourly wage and E is the level of employment. Suppose also that the union’s utility function is given by U = w × E It is easy to show that the marginal utility of the wage fo

> Use DerivaGem to check that equation (19.4) is satisfied for the option considered in Section 19.1. (Note: DerivaGem produces a value of theta ‘‘per calendar day.’’ The theta in equation (19.4) is ‘‘per year.’’)

> Suppose the risk-free rates are as in Problem 4.30. What is the value of an FRA where the holder pays LIBOR and receives 7% (semiannually compounded) for a six-month period beginning in 18 months? The current forward rate for this period is 6% (semiannua

> A trader has a put option contract to sell 100 shares of a stock for a strike price of $60. What is the effect on the terms of the contract of (a) A $2 dividend being declared (b) A $2 dividend being paid (c) A 5-for-2 stock split (d) A 5% stock dividend

> Explain why collateral requirements will increase in the OTC market as a result of new regulations introduced since the 2008 credit crisis.

> A bank offers a corporate client a choice between borrowing cash at 11% per annum and borrowing gold at 2% per annum. (If gold is borrowed, interest must be repaid in gold. Thus, 100 ounces borrowed today would require 102 ounces to be repaid in 1 year.)

> A stock price is $29. A trader buys one call option contract on the stock with a strike price of $30 and sells a call option contract on the stock with a strike price of $32.50. The market prices of the options are $2.75 and $1.50, respectively. The opti

> Call options on a stock are available with strike prices of $15, $1712 , and $20, and expiration dates in 3 months. Their prices are $4, $2, and $12 , respectively. Explain how the options can be used to create a butterfly spread. Construct a table showi

> A trader sells a put option with a strike price of $40 for $5. What is the trader’s maximum gain and maximum loss? How does your answer change if it is a call option?

> What does a stop order to sell at $2 mean? When might it be used? What does a limit order to sell at $2 mean? When might it be used?

> Explain two ways in which a bear spread can be created.

> Use a three-step tree to value an American futures put option when the futures price is 50, the life of the option is 9 months, the strike price is 50, the risk-free rate is 3%, and the volatility is 25%.

> An index provides a dividend yield of 1% and has a volatility of 20%. The risk-free interest rate is 4%. How long does a principal-protected note, created as in Example 12.1, have to last for it to be profitable for the bank issuing it? Use DerivaGem. E

> A foreign currency is currently worth $0.64. A 1-year butterfly spread is set up using European call options with strike prices of $0.60, $0.65, and $0.70. The risk-free interest rates in the United States and the foreign country are 5% and 4% respective

> What is the result if the strike price of the put is higher than the strike price of the call in a strangle?

> A 6-month American call option on a stock is expected to pay dividends of $1 per share at the end of the second month and the fifth month. The current stock price is $30, the exercise price is $34, the risk-free interest rate is 10% per annum, and the vo

> Company X wishes to borrow U.S. dollars at a fixed rate of interest. Company Y wishes to borrow Japanese yen at a fixed rate of interest. The amounts required by the two companies are roughly the same at the current exchange rate. The companies have been

> A stock price is currently $100. Over each of the next two 6-month periods it is expected to go up by 10% or down by 10%. The risk-free interest rate is 8% per annum with continuous compounding. What is the value of a 1-year European call option with a s

> What trading strategy creates a reverse calendar spread?

> On July 1, 2017, a company enters into a forward contract to buy 10 million Japanese yen on January 1, 2018. On September 1, 2017, it enters into a forward contract to sell 10 million Japanese yen on January 1, 2018. Describe the payoff from this strateg

> Suppose that in Table 3.5 the company decides to use a hedge ratio of 1.5. How does the decision affect the way the hedge is implemented and the result? Table 3.5 Data for the example on rolling oil hedge forward. Date Apr. 2017 Sept. 2017 Feb. 2018

> A bank enters into an interest rate swap with a nonfinancial counterparty using bilaterally clearing where it is paying a fixed rate of 3% and receiving LIBOR. No collateral is posted and no other transactions are outstanding between the bank and the cou

> ‘‘A box spread comprises four options. Two can be combined to create a long forward position and two to create a short forward position.’’ Explain this statement.

> An investor believes that there will be a big jump in a stock price, but is uncertain as to the direction. Identify six different strategies the investor can follow and explain the differences among them.

> A trader buys a call option with a strike price of $30 for $3. Does the trader ever exercise the option and lose money on the trade? Explain your answer.

> Use put–call parity to show that the cost of a butterfly spread created from European puts is identical to the cost of a butterfly spread created from European calls.

> Suppose that put options on a stock with strike prices $30 and $35 cost $4 and $7, respectively. How can the options be used to create (a) a bull spread and (b) a bear spread? Construct a table that shows the profit and payoff for both spreads.

> The futures price of an asset is currently 78 and the risk-free rate is 3%. A six-month put on the futures with a strike price of 80 is currently worth 6.5. What is the value of a sixmonth call on the futures with a strike price of 80 if both the put and

> A stock price is currently $50. It is known that at the end of 2 months it will be either $53 or $48. The risk-free interest rate is 10% per annum with continuous compounding. What is the value of a 2-month European call option with a strike price of $49

> When is it appropriate for an investor to purchase a butterfly spread?

> A corn farmer argues ‘‘I do not use futures contracts for hedging. My real risk is not the price of corn. It is that my whole crop gets wiped out by the weather.’’ Discuss this viewpoint. Should the farmer estimate his or her expected production of corn

> Explain why the arguments leading to put–call parity for European options cannot be used to give a similar result for American options.

> What are the numbers in Table 8.1 for a loss rate of (a) 12% and (b) 15%? Table 8.1 Estimated losses to tranches of ABS CDO in Figure 8.3. Losses on Losses to Losses to Losses to Losses to underlying mezzanine tranche equity tranche mezzanine tranche

> A $100 million interest rate swap has a remaining life of 10 months. Under the terms of the swap, six-month LIBOR is exchanged for 4% per annum (compounded semiannually). Six month LIBOR forward rates for all maturities are 3% (with semiannual compoundin

> Why did mortgage lenders frequently not check on information provided by potential borrowers on mortgage application forms during the 2000 to 2007 period?

> Why is an American call option on a dividend-paying stock always worth at least as much as its intrinsic value. Is the same true of a European call option? Explain your answer.

> ‘‘The early exercise of an American put is a trade-off between the time value of money and the insurance value of a put.’’ Explain this statement.

> Give two reasons why the early exercise of an American call option on a non-dividend paying stock is not optimal. The first reason should involve the time value of money. The second should apply even if interest rates are zero.

> What is the impact (if any) of negative interest rates on: (a) The put–call parity result for European options (b) The result that American call options on non-dividend-paying stocks should never be exercised early (c) The result that American put option

> A 5-year bond provides a coupon of 5% per annum payable semiannually. Its price is 104. What is the bond’s yield? You may find Excel’s Solver useful.

> Use the put–call parity relationship to derive, for a non-dividend-paying stock, the relationship between: (a) The delta of a European call and the delta of a European put (b) The gamma of a European call and the gamma of a European put (c) The vega of a

> ‘‘If there is no basis risk, the minimum variance hedge ratio is always 1.0.’’ Is this statement true? Explain your answer.

> In Problem 13.19, suppose a trader sells 10,000 European call options and the two-step tree describes the behavior of the stock. How many shares of the stock are needed to hedge the 6-month European call for the first and second 3-month period? For the s

> Consider a 5-year call option on a non-dividend-paying stock granted to employees. The option can be exercised at any time after the end of the first year. Unlike a regular exchange-traded call option, the employee stock option cannot be sold. What is th

> Explain the arbitrage opportunities in Problem 11.14 if the European put price is $3. Data from Problem 11.14: The price of a European call that expires in six months and has a strike price of $30 is $2. The underlying stock price is $29, and a dividend

> Describe the terminal value of the following portfolio: a newly entered-into long forward contract on an asset and a long position in a European put option on the asset with the same maturity as the forward contract and a strike price that is equal to th

> Give an intuitive explanation of why the early exercise of an American put becomes more attractive as the risk-free rate increases and volatility decreases.

> A 1-month European put option on a non-dividend-paying stock is currently selling for $2:50. The stock price is $47, the strike price is $50, and the risk-free interest rate is 6% per annum. What opportunities are there for an arbitrageur?

> Why do you think the increase in house prices during the 2000 to 2007 period is referred to as a bubble?

> Portfolio A consists of a 1-year zero-coupon bond with a face value of $2,000 and a 10-year zero-coupon bond with a face value of $6,000. Portfolio B consists of a 5.95-year zero-coupon bond with a face value of $5,000. The current yield on all bonds is

> Six-month LIBOR is 5%. LIBOR forward rates for the 6- to 12-month period and for the 12- to 18-month period are 5.5%. Swap rates for 2- and 3-year semiannual pay swaps are 5.4% and 5.6%, respectively. Estimate the LIBOR forward rates for for 18 months to

> A futures price is currently 40. It is known that at the end of three months the price will be either 35 or 45. What is the value of a three-month European call option on the futures with a strike price of 42 if the risk-free interest rate is 7% per annu

> Suppose that in Example 3.2 of Section 3.3 the company decides to use a hedge ratio of 0.8. How does the decision affect the way in which the hedge is implemented and the result?

> A 4-month European call option on a dividend-paying stock is currently selling for $5. The stock price is $64, the strike price is $60, and a dividend of $0.80 is expected in 1 month. The risk-free interest rate is 12% per annum for all maturities. What

> ‘‘When a futures contract is traded on the floor of the exchange, it may be the case that the open interest increases by one, stays the same, or decreases by one.’’ Explain this statement.

> Suppose that a European call option to buy a share for $100.00 costs $5.00 and is held until maturity. Under what circumstances will the holder of the option make a profit? Under what circumstances will the option be exercised? Draw a diagram illustratin

> A corporate treasurer is designing a hedging program involving foreign currency options. What are the pros and cons of using (a) NASDAQ OMX and (b) the over-the counter market for trading?

> ‘‘Employee stock options issued by a company are different from regular exchangetraded call options on the company’s stock because they can affect the capital structure of the company.’’ Explain this statement.

> Suppose that a European put option to sell a share for $60 costs $8 and is held until maturity. Under what circumstances will the seller of the option (the party with the short position) make a profit? Under what circumstances will the option be exercise

> Explain why margin accounts are required when clients write options but not when they buy options.

> Suppose that USD/sterling spot and forward exchange rates are as follows: What opportunities are open to an arbitrageur in the following situations? (a) A 180-day European call option to buy £1 for $1.52 costs 2 cents. (b) A 90-day European

> A U.S. investor writes five naked call option contracts. The option price is $3.50, the strike price is $60.00, and the stock price is $57.00. What is the initial margin requirement?

> What is a mezzanine tranche?

> An index is 1,200. The three-month risk-free rate is 3% per annum and the dividend yield over the next three months is 1.2% per annum. The six-month risk-free rate is 3.5% per annum and the dividend yield over the next six months is 1% per annum. Estimat

> Imagine you are the treasurer of a Japanese company exporting electronic equipment to the United States. Discuss how you would design a foreign exchange hedging strategy and the arguments you would use to sell the strategy to your fellow executives.

> What was the role of GNMA (Ginnie Mae) in the mortgage-backed securities market of the 1970s?

> Under what circumstances are (a) a short hedge and (b) a long hedge appropriate?

> Explain carefully the difference between selling a call option and buying a put option.

> Add rows in Table 8.1 corresponding to losses on the underlying assets of (a) 2%, (b) 6%, (c) 14%, and (d) 18%. Table 8.1 Estimated losses to tranches of ABS CDO in Figure 8.3. Losses on Losses to Losses to Losses to Losses to underlying mezzanine tr

> What differences exist in the way prices are quoted in the foreign exchange futures market, the foreign exchange spot market, and the foreign exchange forward market?

> What is the difference between the operation of the margin accounts administered by a clearing house and those administered by a broker?

> A company has issued a 3-year convertible bond that has a face value of $25 and can be exchanged for two of the company’s shares at any time. The company can call the issue, forcing conversion, when the share price is greater than or equal to $18. Assumi

> Suppose that in September 2018 a company takes a long position in a contract on May 2019 crude oil futures. It closes out its position in March 2019. The futures price (per barrel) is $48.30 when it enters into the contract, $50.50 when it closes out its

> Explain how CCPs work. What are the advantages to the financial system of requiring CCPs to be used for all standardized derivatives transactions between financial institutions?