AMERICAN INTERNATIONAL COMPANY Harvard Case Solution & Analysis

AMERICAN INTERNATIONAL COMPANY Case Solution

The report is further broken down into three tasks; each task represents different scenarios with respect to hedging, the report will also cover the end result of each hedging scenario which will also cover why the portfolio is profitable or In case of loss why the portfolio is not profitable the analysis is as follows.

TASK 1

In the case it is assumed that ATM (at the money) call option is sold to you a customer, the strike price is taken as the closing price of day 1, as we all know that in case of at the money call option the spot and strike price same and there is no intrinsic value of the option but it has some time value depends upon the time to expiry and volatility of the option under consideration. The closing stock prices of the American international company is downloaded and projected according to the guidelines in the case. One contract is equal to 100 options; the premium was also calculated using the prevailing market price of shares.

The market to market marking was carried out and the call option was recalculated to record option on current price and any difference between the current and the price at which the option was initially bought was appropriately recorded.

The portfolio was generally made some losses when asset price was recorded using mark to market methodology after the premium on call options and mark to market the price the loss is recorded. For task one different volatility rates are used for each day to project the price of option with respect to volatility, further more the price of option is computed using black schole model for option pricing and after computing the option price the volatility is applied for the rest of the time to expiry. The hedge ratio was calculated suing the price of the option and number of contracts to hedge the position from negative movements in the price.

Moreover the ATM call option price was further computed using the NYSE volatility of the share price of AIG. The excel file can be referred to understand how the black schole model is applied to calculate option price. The hedge ratio was calculated to re hedge the position of option to adjust number of contracts which will be required which will be appropriate for hedging the position in the market. The portfolio was not profitable may be because downward movements in the price of the underlying security or because of different volatility which is being used throughout to the time of expiry

TASK 2

In task 2 the option pricing is carried out using the market given implied volatility which is -0.05 and then volatility for remaining days is calculated using the difference of new and old volatility. From the end of day 2 the change in stock price is recorded in terms of mark to market. After that according to new price the delta hedge is calculated to incorporate losses suffered and also to once again make portfolio delta-neutral. The further projections are carried out using same data to the next 20 days, the gain was seen when the new price of option was deducted from the closing strike price.....................

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