Financial Derivatives: Options and Futures Pricing Problems
Interest Rates, Forwards, and Futures Contracts
Alba, having worked all summer, would like to deposit her money to earn extra income. A bank offers her 5% compounded semiannually. A friend starting a new business offers her 4.92% compounded quarterly. Which option is better and why?
Solution: We compare the effective annual rates.
- Bank Offer: \((1 + \frac{0.05}{2})^2 – 1 = 5.0625\%\)
- Friend’s Offer: \((1 + \frac{0.0492}{4})^4 – 1 \approx 5.012\%\)
The first option is better because it yields a higher
Fama-French Three-Factor Model vs. CAPM Risk Factors
Important Risk Factors in Asset Pricing
Industry Factor
- FIndustry = RIndustry – RStocks: Stocks in the same industry are all exposed to industry-specific shocks (demand, prices, technology).
- This implies stocks in the same industry tend to have higher correlations with each other.
- Stocks in an industry will have a large beta with respect to that industry’s factor (BIndustry). Stocks in nearby industries will have moderate BIndustry, and stocks in unrelated industries will have zero BIndustry.
Size
Read MoreBusiness Entity Tax Comparison: S-Corp, C-Corp, & LLC
Key Factors in Choosing a Business Tax Entity
Qualified Business Income (QBI) Deduction
- Provides a 20% deduction on qualified business income.
- Available for S-Corporations and Partnerships (pass-through entities).
- Not available for C-Corporations.
- Subject to income thresholds (e.g., for 2024: $191,950 for single filers and $383,900 for joint filers), above which the deduction may be limited or phased out.
Self-Employment (SE) Taxes
- Tax Base: Net earnings from self-employment * 0.9235.
- Rates: 12.4% for Social
Financial Markets & Investment Concepts: Core Principles
1. Efficient Market Hypothesis: Strong Form & Abnormal Returns
According to the strong form of the efficient market hypothesis, which of the following activities can still generate abnormal returns?
- a) Technical analysis
- b) Fundamental analysis
- c) Insider trading
- d) Active asset management
- e) None of the above
Since strong form efficiency implies all information (public and private) is already incorporated in prices, none of the above activities can generate abnormal returns.
2. Security Market Line
Read MoreFixed Income Markets: Trading & Portfolio Strategies
The Secondary Bond Market Explained
The secondary market refers to all bond transactions that take place after the bond’s initial settlement in the primary market and before its maturity, early redemption, or cancellation. Unlike equity markets, which have long operated with high levels of organization and transparency, fixed income markets have traditionally been more opaque, especially in terms of price discovery and trade reporting. However, since the financial crisis of 2008-2012, regulation
Read MoreEssential Financial & Accounting Terms Defined
Essential Financial & Accounting Terms
Accounting Function
Summarizing economic transactions.
Aging Schedule
Classification of accounts receivable by time outstanding.
American Option
An option that can be exercised at any time before its expiration date.
Annuity
An asset that pays a fixed sum each year for a specified number of years.
Authorized Share Capital
The maximum number of shares that a company is permitted to issue, as specified in the firm’s articles of incorporation.
Banker’s Acceptance
An
Read More