UNIVERSITY OF ILLINOIS AT URBANA-CHAMPAIGNCollege of Business – Department of FinanceFINANCE 432: Financial Risk Management for InsurersProfessor Stephen D’Arcy.Homework #2 (10 points)Lectures 5-6Due February 11, 2008(1 point)1. Based on interest rate parity, what is today’s one-year forward rate in terms of € / $ if the current spot rate is €0.67 / $1, the yield on 1-year US Treasuries is 2.11%, and the yield on a 1-year, risk-free asset in Europe is 3.77%?(2 points)2. Assume the current price for Crude Oil futures for December 2008 delivery is $95 per barrel and the current spot price is $89.50. Assume that the spot price in December 2008 is expected to be $90, and that it actually turns out to be at that level. Draw a graph that illustrates the likely path of the futures price of this contract from now until contract maturity. What term is used to describe this pattern? Explain how this pattern could occur.(2 points)3. What is the fixed rate on an annual interest rate swap if the floating side pays LIBOR? AssumeLIBOR spot rates are as follows:Period LIBOR Spot Rate1 Year 3.27%2 Years 4.34%3 Years 5.39%(2 points)4. A US company enters into a three year swap contract with a Japanese bank that has annual settlement dates. The notional amount is $1 million (107 million Yen). Each side pays an interest rate of 5%. For each of the following time periods, indicate the amount each side would owe and the net payment the US company would receive (indicate a net payment as a negative number). Year Japanese Yen(per US dollar)US CompanyOwes (in $)Japanese BankOwes (in $)Net Amount (in $to US Company)0 1071 1112 1053 108(3 points)5. Use the Black-Scholes Option Pricing Model to answer the following questions.A. A stock currently sells for $48. The exercise price on a call option with 9 months until expiration is $52. If the risk-free rate is 3.2% and the stock has an assumed volatility of 0.4, what is the price of the call option?B. Which of the following would increase the value of that call option?1. Changing the expiration date to 6 months from now2. Changing the exercise price to $463. Changing the assumed volatility to 0.24. Changing the risk-free rate to 4.0%C. Use the put-call parity relationship to find the price of a put with the same characteristics asthe call in question A. Why should you not be surprised that it is worth so much
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