2019 April CM2B Q2

[iamminime]

Hi

In 2019 April CM2B Q2
When we do part(i), we find the volatility by setting Value of Call option equal to value of Other assets by Goal Seek
However, in part(ii) and part(iii), when the £10m loan is received, is it reasonable to just leave the Value of Call option not equal to value of other assets? I think it affects the probability to repay the loan?

Thanks a lot!

 

[John Potter]

Are you looking at the Examiners' report or our ASET? I'm not sure we agree on part (i), there are other complications here aside from this interesting one that you point out. For example, Part (i) asks you to calculate the implied volatility before any additional borrowing. However, there appears to be some existing borrrowing in the Data worksheet that is not mentioned in the question wording.

We also include the additional £10m in the asset side too in part (ii), which would then mean your good question is answered.

John

 

[AKS01]

Hi,

For part (i) I correctly allowed for the debt interest rate when calculating the strike price.
However, reading the question again it states that the £10m loan the bank is offering would be offered with a 10% interest rate.
Why would we assume that their current debt value is also going to accumulate at the same interest rate?

Also, initially for part (i) I set the call option to the value of "Other assets" rather than the share price x shares in issue.
I thought that Total assets = debt value + equity
So I took that to mean that the equity value = total assets - debt value

Thanks

 

[Steve Hales]

In the absence of any specific information, 10% pa would be a reasonable assumption. However, when making such assumptions it's always a good idea to state them clearly!