Reference no: EM133204687

QUESTION 1

You believe that the current escalation in global politics will increase the volatility in the stock price of BP plc currently trading at $28.93. The following option contracts are available in the market:

Call option with premium at $1.06 and strike price of $30

Call option with premium at $0.68 and strike price of $31

Put option with premium a $1.76 and strike price-of$30 4. 

Put option with premium at $1.21 and strike price-of$29

1. How can you combine the above options to benefit from a potential increase in volatility in the share price of BP plc using the Straddle and Strangle strategies?
2. What will your profit be if the price moves to a) $35 or b) $31 after one month for each of the two strategies?
3. Which strategy would you follow if you expected a decline in price volatility? Use examples of price changes to demonstrate the advantages and disadvantages of this strategy.

QUESTION 2

Sam's firm has lent £3,000,000 to Monika's firm. Monika's firm has not been performing well in the last few months and bankruptcy is a realistic scenario. Sam is getting worried about receiving back the money that his firm invested and hires you to calculate the risk exposure. The recovery rate is 20%, the probability of survival in the previous period is 50% and the hazard rate is 25%.

Required:

1. Calculate the loss given default, the probability of default and the expected loss.
2. Explain what your findings mean for Sam's firm.