- 7 Marks
FM – May 2016 – L3 – Q6a – Financial Risk Management
Calculating the number of call options needed to delta-hedge the position of a bank's investment in shares.
Question
You work in the corporate finance department of a major bank. The bank has invested in 20,000,000 shares of Ode Oil Plc. You are concerned about the recent volatility in Ode Oil Plc’s share price due to the recent instability in the global oil market. You plan to protect the bank’s investment from a possible fall in Ode Oil Plc’s share price for the next three months and do not plan to sell the shares at present.
You have the following additional information:
- Ode Oil Plc’s current share price: N10
- Call option’s current share price: N11
- Option expiry: 3 months
- Interest rate (annual): 8%
- Ode Oil Plc’s share annual standard deviation: 64%
You are required to calculate:
How many call options you need to buy or sell in order to delta-hedge the bank’s position. Please be specific.
Note: Delta may be estimated using N(d1).
Find Related Questions by Tags, levels, etc.
- Tags: Call Options, Corporate finance, Delta Hedging, Risk Management, Share Price Volatility
- Level: Level 3
- Topic: Financial Risk Management
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