...Concept of Free Market Economy with focus to Indian Economy and options for Bangladesh 1 1.0 INTRODUCTION Free market economy has become the only economic system dominating the world after the collapse of socialism in Soviet Union and other East European countries. Today, the application of market mechanism is widespread all over the world. The free flow of capital and goods throughout the world has made the world like a single village. Success of countries practicing free market is only evident with the growth of the USA, the Scandinavian countries, Germany and France as major world powers. Countries such as India and China, by allowing liberalization of its trade to some extent and practicing free market principles brought about more efficiency among its domestic producers and increased its growth rate markedly. Free market existing with the doctrines of Socialism like limited regulation of prices by the government to protect the poor can be an ideal situation for developing countries like India, China and South East Asian countries to attain growth and prosperity. 2.0 FREE MARKET ECONOMY The term free market economy primarily means a system where the buyers and sellers are solely responsible for the choices they make. In a way, free market gives the absolute power to prices to determine the allocation and distribution of goods and services. These prices, in turn, are fixed by the forces of supply and demand of a respective commodity. In cases of demand falling short...
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...Explain how the option pricing formula developed by black and scholes can be used for common stock and bond valuation. Include in your discussion the consequences of using variance applied over the option instead of actual variance. Its generally known that Black and Scholes model became a standard in option pricing methods , with almost everything from corporate liabilities and debt instruments can be viewed as option (except some complicated instruments), we can modify the fundamental formula in order to fit the specifications of the instrument that will be valued. An argument done by Black and Scholes which was based on the past proposition of Miller and Modigliani a well as assuming some ideal conditions, States that value of the firm is a sum of total value of debt plus the total value of common stock. As well as the fact that in the absence of taxes, the value of the firm is independent of its leverage and the change of debt has no effect on the firm value. V = E + Dm V: value of the firm. E: shareholders right (common stock values). Dm: market value of the debt. As the above equation impose that Equity (common stock values) can be viewed as a call option on the firm value (due to the shareholders limited liability and with consideration that firm debt can be represent as a zero-coupon bond), where exercising the option means that equity holders buy the firm at the face value of debt (which is in this case will be the exercise price of the option), on the liquidation...
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...Traditional VS Islamic Financial Derivatives To: Prof. Naser Abu Mustafa By: Mwaffaq Al Jayousi & Mohammad Al Shdooh Abstract This study focuses the light on defining financial derivatives and briefly describe their different types (Options, Forwards, Futures, Swaps, etc.). At the same time it tries to find if these financial derivatives exists in the Arab world, how they are implemented, and if we have an Islamic alternatives for them. Introduction There is a big debate in the Arab world regarding the usage of financial derivatives, Wither they are legal according to Islam or not, and If they are illegal in Islam; are there any Islamic alternatives to them. First we have to ask our self: Is there any need to use derivatives? And why they recently became so popular in the western countries? The need for financial derivatives emerges when people realize that there must be a way to reduce the risk associated with the trading of different kinds of goods. Risks such as price fluctuations and the uncertainty about the future market conditions. And since there are some people who are willing to bear this risk instead of us, this market took off and recently because of the communications revolution it flourished. Then why these financial derivatives did not reach the Arab world? The answer is simply because they hugely rely on speculations and anticipation; which are considered illegal according to Islam. But someone can ask: if it is illegal in Islam, then how come we...
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...Options Theory Applied to Alternative Energy Industry Christina Clowdus Bus: 630 March 20, 2012 Dr. Shaw Introduction In life, you always have options. It is no different in capital investment. In today's unpredictable business world, managers recognize how risky the most valuable investment opportunities often are, and how useful a flexible strategy can be. That's why they want to know all their options. Yet many current financial assessment tools fail to identify what investors can do to capitalize on future uncertain events. “Managerial flexibility to adapt and revise future decisions in order to capitalize on favorable future opportunities or to limit losses has proven vital to long-term corporate success in an uncertain and changing marketplace” (Brennan, M.J. and E.S. Schwartz 1985, p. 15). Utilizing a real options strategy allows businesses to capture the value of managerial flexibility in adapting decisions in response to unexpected market developments. When used as a conceptual tool, real options allow management to characterize and communicate the strategic value of an investment project (Bjerksund, P. and S. Ekern 1990). Traditional methods (e.g. net present value, discounted cash flow) fail to accurately capture the economic value of investments in an environment of widespread uncertainty and rapid change. Using real options theory, managers can more effectively target crucial opportunities to redeploy, delay, modify, or even abandon capital-intensive projects...
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...enhance the ability to differentiate risk and allocate it to those investors who are most able and willing to take it -- a process that has undoubtedly improved national productivity, growth and standards of living. Derivatives products provide certain important economic benefits such as risk management or redistribution of risk away from risk-averse investors towards those more willing and able to bear risk. Derivatives also help price discovery, i.e. the process of determining the price level for any asset based on supply and demand. All markets face various kinds of risks. This has induced the market par-ticipants to search for ways to manage risk. The derivatives are one ofthe categories of risk management tools. As this consciousness about risk management capacity of derivatives grew, the markets for derivatives de-veloped. Derivatives markets generally are an integral part of capital markets in developed as well as in emerging market economies. These instruments assist business growth by disseminating effective price signals concerning exchange rates, indices and reference rates or other assets and thereby render both cash and derivatives. This book provides basics about Derivatives. i.e. What...
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... II. Case Analysis: Commodity Market Derivatives Case Solutions: 1. Discuss the risk exposure of Amarnath hedge fund. Ans: The Amaranth hedge fund was exposed to following risks: a. Market risk: The risk that occurs from the volatility of investment returns b. Liquidity risk: It measures the degree of difficulty in exiting a given trading position c. Funding risk: It measures the extent to which they were able to meet margin calls on their natural gas position d. Capacity risk: The risk due to putting too much money into one particular strategy 2. What are the negatives to rolling a spread position? Ans: Negatives to rolling a spread position are: When rolling a spread position the investor expects the following months to which the contract was rolled over to be favourable and thus be able to unload its positions. But, if the market moves in a direction opposite to the one anticipated by the investor it can result in huge losses. Also, if the risk increases for a spread position with the increase in the leverage. In the case of Amaranth hedge fund, it had rolled its short positions prior to august into the next month, hoping that market conditions would change and enable it to unload its positions. There were now no more summer months into which it could roll these positions. By late August, with hurricane season almost over and natural gas supplies plentiful, it appeared likely there would be adequate supplies for the winter. The market fundamentals were strongly indicating...
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...Fin (IB) 3551: International Finance Homework Problem set #2 Problem Set 2 (problems only) – BOP, crisis, currency derivatives, corporate risk I BOP 1. According to popular opinion, U.S. trade deficits indicate any or all of the following: a lack of U.S. competitiveness owing to low productivity or low-quality products and/or lower wages, superior technology, and unfair trade practices by foreign countries. Which of these factors is likely to underlie the persistent U.S. trade deficits. Comment/Explain. Although popular opinion believes these factors are likely to underlie the trade deficits, none of these factors underlie the persistent U.S. trade deficits. These factors affect other countries more than the U.S. however run trade surplus. American trade deficits reflect the U.S. savings deficit. 2. Identify the correct BOP account for each of the following transactions. a. A German-based pension fund buys U.S. government 30-year bonds for its investment portfolio. Financial account: portfolio investment liabilities b. Scandinavian Airlines System...
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...FINANCIAL DERIVATIVES (A Future of Indian Financial Market) Dr. Ritu Kothiwal, Associate Professor, BIET, Hyderabad Contact No: 09246193330 Email Id: kothiwal55@gmail.com Mr. Ankur Goel, Research Scholar (Management), Mewar University, GZB. Contact No: 9917745990 Email Id: mrankurgoel@gmail.com. ABSTRACT Among all the innovations that have flooded the international financial markets, financial derivatives occupy the driver's seat. These specialized instruments facilitate the shuffling and redistribution of the risks that an investor faces. Thus aids in the process of diversifying ones portfolio. The volatility in the equity markets over the past years has resulted in greater use of equity derivatives. The volume of the exchange traded equity futures and options in most of the mature markets have seen a significant growth. It goes beyond that the local derivative in the emerging markets have witnessed widespread use of the derivative instrument for a variety of reasons. This continuous growth and development by the emerging market participants has resulted in capital inflows as well as helped the investors in risk protection through hedging. INTRODUCTION AND CONCEPT OF DERIVATIVES: Derivatives are financial contracts whose values are derived from the value of an underlying primary financial instrument, commodity or index, such as: interest rates, exchange rates, commodities, and equities. The International Monetary Fund defines derivatives as "financial...
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...2: "Which of the following is an agreement to buy or sell an asset at a fixed date in the future, for a fixed price? 1. Swaps 2. Futures 3. Forwards 4. Warrant 2: "_ Are derived by continuously computing the average of the most recent n day’s closing prices. 1. Moving Average 2. Quotes 3. Commodities plots 4. Plots 2: "What is the conversion factor of a US Treasury bond if securities coupon is 6 percent 1. 1 2. 2 3. 3 4. 6 2: "Which of the following are market instruments that are low risks, highly liquid, short term debt instruments issued by governments, financial institutions and corporations? 1. Derivatives 2. Financial Assets 3. Money Market Securities 4. None of the Above 2: "According to this theory, movement in financial markets depends on attitudes of investors on the business cycle. 1. Dow Theory 2. Cycle Theory 3. Elliot Wave Theory 4. None of the above 2: "Which of the following is a measure of the average change in prices of goods and represent inflation at the consumer level 1. Consumer price index 2. Implicit price deflator 3. Gross domestic product 4. None of the above 2: "What Happens when fiscal policy is paralyzed due to political statement of budget constraints 1. Revert to the economic policy established by the goverment 2. Monetary policy will be relied on 3. Opt to the financial policy 4. None of the above 2:...
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...Demystifying T 20 The Milken Institute Review The Merriam-Webster dictionary defi nes a derivative in the fi eld of chemistry as “a substance that can be made from another substance.” Derivatives in fi nance work on the same principle. These fi nancial instruments promise payoffs that are derived from the value of something else, which is called the “underlying.” The underlying is often a fi nancial asset or rate, but it does not have to be. For example, derivatives exist with payments linked to the S&P 500 stock index, the temperature at Kennedy Airport, and the number of bankruptcies among a group of selected companies. Some estimates of the size of the market for derivatives are in excess of $270 trillion – more than 100 times larger than 30 years ago. When derivative contracts lead to large fi nancial losses, they can make headlines. In recent years, derivatives have been associated with a few truly notable events, including the collapses of Barings By René M. Stulz Financial Derivatives Third Quarter 2005 21 Bank (the Queen of England’s primary bank) and Long-Term Capital Management (a hedge fund whose partners included an economist with a Nobel Prize awarded for breakthrough research in pricing derivatives). Derivatives even had a role in the fall of Enron. Indeed, just two years ago, Warren Buffett concluded that “derivatives are fi nancial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” michael...
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...Exploiting Volatility In the times of recession and variability with the market getting volatile with very far glimpse of normalcy being stored, it would not be a good suggestion to just sit and watch rather it would be a better strategy to make ways to scale up the investment by learning to exploit volatility by diversifying asset allocation, rebalancing portfolio and option strategies. High return volatility definitely increases the fluctuation of the asset class weightings around the target allocation and increases the risk of significant deviation from the target but greater volatility also results in compounded returns . It is substantiated by the situation when the government is spending trillions of dollars to stimulate the growth in the economy and the corporate world is moving ahead with aggressive restructuring. Volatility can be exploited by diversifying the portfolio with bonds as bonds and equities are well correlated and the bonds in the portfolio also dramatically reduces the risk during financial crises. There would be loss but by a lower percentage than in the situation of all equity or lower bond ratio portfolios. The second situation is to avoid risk of market concentration when there is subsequent rise in equity market and then sudden collapse. For this systematic rebalancing is very advantageous as it reduces the downside risk by reducing volatility and investors increase long term portfolio performance by creating alpha and reducing risk. This approach...
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...this paper is to present a way for such countries to meet their financial needs and to protect their banking sectors. Unlike businesses or corporations, countries have access to natural resources which can be got and sold on the world market for a profit. Some countries even have an immediate market for their minerals like oil and gold. Almost all LDCs and a number of the other countries that needed bail out funds, have these resources that can be sold for profit. However in a situation where quick funds are needed, selling these resources would take a considerably long period of time which is not available at that instance. This can be remedied by the sell of long term covered call options on the resources of the different countries that need the funds. An options strategy is when an investor holds a long position (owns the asset: in our case mineral) in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset. This strategy is often employed when an investor has a short-term neutral view on the asset and for this reason holds the asset long and simultaneously have a short position via the option to generate income from the option premium.By selling Long term covered call options, the country makes money that not only can be used to fund bailouts but can also be used for other budgetary expenditures. To expand on this...
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...Grade Details - All Questions | 1. | Question : | (TCO C) Blease Inc. has a capital budget of $625,000, and it wants to maintain a target capital structure of 60 percent debt and 40 percent equity. The company forecasts a net income of $475,000. If it follows the residual dividend policy, what is its forecasted dividend payout ratio? (a) 40.61% (b) 42.75% (c) 45.00% (d) 47.37% (e) 49.74% | | | | Instructor Explanation: | Answer is: d Text: pp. 570-572 - Residual Dividends, Chapter 14 Capital budget $625,000 Equity ratio 40% Net income (NI) $475,000 Dividends paid = NI - (Equity ratio)(Capital budget) $225,000 Dividend payout ratio = Dividends paid/NI 47.37% | | | | Points Received: | 10 of 10 | | Comments: | | | | 2. | Question : | (TCO F) Chocolate Factory's convertible debentures were issued at their $1,000 par value in 2009. At any time prior to maturity on February 1, 2029, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price, Pc? (a) $40.00 (b) $42.00 (c) $44.10 (d) $46.31 (e) $48.62 | | | | Instructor Explanation: | Answer is: a Chapter 19: pp. 770-774 Par value: $1,000.00 Conversion ratio: 25.00 Conversion price = Par value/Conversion ratio = $40.00 | | | | Points Received: | 10 of 10 | | Comments: | | | | 3. | Question : | (TCO B) Ang Enterprises has a levered beta of 1.10, its capital structure consists of 40 percent debt...
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...------------------------------------------------- Chapter 20 Decision Trees, Real Options, and Other Capital Budgeting Topics ------------------------------------------------- ANSWERS TO END-OF-CHAPTER QUESTIONS 20-1 a. Real options occur when managers can influence the size and risk of a project’s cash flows by taking different actions during the project’s life. They are referred to as real options because they deal with real as opposed to financial assets. They are also called managerial options because they give opportunities to managers to respond to changing market conditions. Sometimes they are called strategic options because they often deal with strategic issues. Finally, they are also called embedded options because they are a part of another project. b. Investment timing options give companies the option to delay a project rather than implement it immediately. This option to wait allows a company to reduce the uncertainty of market conditions before it decides to implement the project. Growth options allow a company to expand if market demand is higher than expected. This includes the opportunity to expand into different geographic markets and the opportunity to introduce complementary or second-generation products. It also includes the option (an abandonment option) to abandon a project if market conditions deteriorate too much. Flexibility options allow a company to have flexibility in their operations, such as the flexibility...
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...Derivatives Markets: Futures and Options December 9, 2013 Authored by: Kelly Smith Derivatives Markets: Futures and Options December 9, 2013 Authored by: Kelly Smith | Silver Bear Put Spread | | An investment strategy to capitalize on a forecasted weakness in the silver spot market | | Silver Bear Put Spread | | An investment strategy to capitalize on a forecasted weakness in the silver spot market | Hypothesis – Silver Prices Forecasted to Decline Based on key macro and micro economic indicators relevant to the silver market, I conclude that spot silver prices will continue to decline in both the short and long term. Several noteworthy firms also support this hypothesis, including UBS, CPM Group, and HSBC Holdings. UBS, for example, lowered their 2014 silver price forecast December 2, 2013, citing that “the new year will likely tempt investors to move out of precious metals into other assets.” They lowered their average price expectations for silver from $25 previously to $20.50/oz. for 2014 and from $24 to $21 in 2015. For the purpose of this assignment, I am assuming the role of a speculator. As such, I will open a Silver Bear Spread with the intention to capture a significant short-term profit – the intended result based on my hypothesis that silver prices will continue to trend lower. Silver Supply and Demand Economics Industrial demand growth, driven by technology advances for several decades, appears to have plateaued. In...
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