Q1. Explain the similarities and the differences between ABS and ABS CDO. Q2. Su
ID: 2711811 • Letter: Q
Question
Q1. Explain the similarities and the differences between ABS and ABS CDO.
Q2. Suppose you paid $5 for a $20 call option (strike price = $20) months ago. This option expires today and the current stock price is $22. If you exercise the call, the call payoff is $2 (=$22 - $20) and the profit will $2 - $5 = -$3. Should you exercise or not exercise the call? Explain.
Q3: What are the differences between (a) (exchange-traded) call options and (b) warrants/employee stock options/convertibles?
Q4. The current price of a stock is $94, and a three-month European call option with a strike price of $95 currently sells for $4.70. An investor who feels that the price of the stock will increase is trying to decide between investing in 100 stocks and investing in 2,000 call options (20 contracts) for 3 months. Both strategies cost an initial investment of $9,400. How high does the stock price have to rise in 3 months for the option strategy to be more profitable than the stock strategy? In other words, at what stock price in 3 months, will the 2 strategies result in the same profit?
Explanation / Answer
1 ABS is a security backed by pool of loans or receivables (Assets), and CDO “are backed by pool of one or more debt obligations An asset-backed security (ABS) is a security created by pooling non-mortgage assets that is then resold to investors A collateralized debt obligation (CDO) is a complex type of ABS that can be based on non-mortgage assets, mortgage assets or both together. A CDO is an ABS issued by a special purpose vehicle (SPV), which is a business entity or trust formed specifically to issue the CDO ABSs are backed by credit card receivables, home equity loans, student loans, auto loans and other non-mortgage financial vehicles. 2 Yes we should exercise the option else the loss will be -5 instead of -3 3 Exchange traded option The contract is standardized so that underlying asset, quantity, expiration date and strike price are known in advance There is no default reisk as it has a central counterparty. The benefits to exchange-traded options are the liquidity of the options, standardized contracts, quick access to prices and the use of clearing houses by exchanges. Employee stock option carry the right, but not the obligation, to buy a certain amount of shares in the company at a predetermined price An employee stock option is slightly different from a regular exchange-traded option because it is not generally traded on an exchange, and there is no put component. convertibles and warrents have similar properties they give the right but there is no obligation 4 current price 94 strike 95 premium 4.7 Investment in 100 stock 9400 2000 call 9400 Payoff Stock price@100 600 call option 600 At stock price 100 both payoff will be same
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