Financial Market Past Paper

Question 1

The shares of Four Season Plc are currently priced at 415p. The call options have an exercise

price of 400p and are due to expire in three months’ time. The risk free interest rate is 5%

and Four Season’s price volatility as measured by the standard deviation is 22%.

Using Black and Scholes option valuation model and the put-call parity theorem, you are

required to calculate:

a) the value of the Four Season call options (25 marks)

b) the value of Four Season’s put options with the exercise price of 400p with a three month

expiry (15 marks)

c) Discuss the problems associated with Black and Scholes Option Valuation Model

(25 marks)

d) Explain the difference between the stock price, the exercise price, and the option premium.

Which of these are determined by the forces of supply and demand? (35 marks)

(Total - 100 marks)

Question 2

Kram plc is considering investing in one of two short-term portfolios of four short-term

financial investments in different industries. The correlation between the returns of the

individual components of these investments is believed to be negligible.

Portfolio 1

Standard

deviation of Amount

Investment Beta Expected return return invested

% % £million

A 1.4 16 7 3.8

B 0 6 2 5.2

C 0.7 10 5 6.1

D 1.1 13 13 2.9

18.0

Portfolio 2

Standard

deviation of Amount

Investment Beta Expected return return invested

% % £million

A 1.2 14 9 7.1

B 0.8 11 4 2.7

C 0.2 7 3 5.4

D 1.5 17 14 2.8

18.0

3 P13302-E1

P13302-E1

The managers of Kram are not sure of how to estimate the risk