Ivey Publishing

Fundamentals of Futures and Options Markets

Hull, J.C.,6/e (United States, Pearson, 2008)
Prepared By Zheng Liu, Ph.D. Student (Finance)
Chapter and Title Chapter Matches: Case Information
Chapter 1:

Walid Busaba, Zeigham Khokher, Jaclyn Grimshaw

Product Number: 9B05N013
Publication Date: 8/12/2005
Revision Date: 10/4/2009
Length: 11 pages

A derivative is a financial instrument that's value, as its name suggests, is derived from the value of an underlying asset or security. There are many different derivative securities available, including: forwards, futures, options, rights, warrants, convertibles and swaps. This note introduces some of the key concepts, terminology and strategies associated with these derivatives.

Issues: Derivatives; Options; Forwards; Futures
Difficulty: 4 - Undergraduate/MBA

Chapter 2:
Mechanics of Futures Markets

Robert W. White, Jim Fisher

Product Number: 9A96B019
Publication Date: 5/14/1996
Revision Date: 2/5/2010
Length: 13 pages

The deregulation of the natural gas industry permitted the creation of new companies, gas marketers or gas banks, such as CoWest. Still in its first year of operations, CoWest had the opportunity to bid on a fixed-price long-term contract to supply gas to a cogeneration plant. The focus of the case is to investigate the possibilities of putting a deal together using financial derivatives.

Teaching Note: 8A96B19 (27 pages)
Industry: Utilities
Issues: Risk Management; Derivatives; Bidding
Difficulty: 4 - Undergraduate/MBA

Chapter 3:
Hedging Strategies Using Futures

Stephen Sapp

Product Number: 9B05N024
Publication Date: 11/28/2005
Revision Date: 11/4/2009
Length: 8 pages

The president of a small Canadian tour operator of packaged vacations faces foreign exchange risk resulting from a future transaction in which the firm is committing to pay in U.S. dollars where the company's revenues are in Canadian dollars. The thin profit margins require the company to consider different hedging alternatives. The case provides significant information that will allow students to discuss international parity conditions and various hedging strategies within a relatively simple context.

Teaching Note: 8B05N24 (6 pages)
Industry: Arts, Entertainment, Sports and Recreation
Issues: Derivatives; Strategic Planning; Hedging; Risk Management
Difficulty: 4 - Undergraduate/MBA

Stephen Sapp

Product Number: 9B00N022
Publication Date: 2/2/2001
Revision Date: 1/12/2010
Length: 3 pages

Lufthansa, the flagship German airline, was undertaking an aggressive expansion program. The chairman of the board had negotiated a deal with Boeing for the purchase of 20 new aircraft at a cost of US$500 million. The U.S. dollar was at historic highs and he had to decide how much, if any, of the US$500 million purchase price to hedge and best method to use. Since Lufthansa's revenues were mainly in deutsche marks and this amount was payable in one year, he needed to determine how to deal with the resulting foreign exchange risk by examining principle foreign exchange hedging strategies. Covenants restricting Lufthansa to take on new debt made it critical that he be sure of the financing and risk exposure before finalizing the deal.

Teaching Note: 8B00N22 (6 pages)
Industry: Transportation and Warehousing
Issues: Exchange Rates; Risk Management; International Finance; Hedging
Difficulty: 4 - Undergraduate/MBA

Chapter 4:
Interest Rates

Stephen R. Foerster, Rob Barbara

Product Number: 9A95B045
Publication Date: 1/29/1996
Revision Date: 2/12/2010
Length: 18 pages

The treasurer of The University of Western Ontario was preparing a recommendation to the Spencer Hall board of directors concerning the financing of the $7.7 million expansion to Spencer Hall. The expansion was currently being financed with short-term loans but the board was concerned about increasing rates and was considering such hedging vehicles as interest rate swaps, caps and collars. A follow-up case is available (9A97N004).

Teaching Note: 8A95B45 (6 pages)
Industry: Finance and Insurance
Issues: Loan Evaluation; Interest Rates; Hedging; Financial Strategy
Difficulty: 4 - Undergraduate/MBA

Robert W. White, Graham Carter

Product Number: 9A90B037
Publication Date: 1/1/1990
Revision Date: 3/15/2002
Length: 17 pages

A positive covenant on a $200 MM floating rate loan required Columbia River Pulp (CRP) to hedge a minimum of $100 MM for at least three years at a maximum rate of 12 percent. The alternatives included interest rate SWAPs, CAPs and COLLARs. What is the optimal hedging structure? Should CRP hedge all of its floating rate debt, or only the amount required under the loan agreement? (This case can be used with two related cases bearing the same name, 9A95B034 and 9A90B036. A Microsoft Excel spreadsheet is available for use with this case, product 7A90B037.)

Teaching Note: 8A90B37 (169 KB)
Industry: Manufacturing
Issues: Derivatives; Risk Management; Bank Lending; Financial Strategy
Difficulty: 4 - Undergraduate/MBA

Chapter 5:
Determination of Forward and Futures Prices

Robert W. White, Justin Pettit

Product Number: 9A95B032
Publication Date: 11/7/1996
Revision Date: 2/11/2010
Length: 16 pages

The focus of the case is on deal-making in the context of a structured note. The challenge for the student is the placement of US$125 million of Special Purpose Trust (SPT) paper. The financing was to fund SPT's forward purchase of a portion of the future oil production. The structure of the note has to be modified in order to place the paper in a short period of time.

Teaching Note: 8A95B32 (251 KB)
Industry: Finance and Insurance
Issues: Derivatives; Bank Lending; Securities; Risk Management
Difficulty: 4 - Undergraduate/MBA

Chapter 6:
Interest Rate Futures

Robert W. White, Jeff Poulsen

Product Number: 9A99N034
Publication Date: 2/9/2000
Revision Date: 1/21/2010
Length: 3 pages

An innovative financial services provider is struggling to arrive at a fixed interest (or SWAP) rate needed by its client. The client's new project would take five years to reach capacity, at which time debt repayments would begin. Hence the client needed to lock in interest rates for the first 10 years of the project. To arrive at a price, the financial services provider planned to start with the zero coupon rate bond yield curve, testing various points along the curve. (The teaching note for this case consists of a PowerPoint presentation. A Microsoft Excel spreadsheet is also available for use with this case, product 7A99N034.)

Teaching Note: 8A99N34 (377 KB)
Industry: Finance and Insurance
Issues: Derivatives; Pricing; Zero Curves
Difficulty: 4 - Undergraduate/MBA

Chapter 7:

Stephen Sapp

Product Number: 9B05N018
Publication Date: 10/28/2005
Revision Date: 10/4/2009
Length: 19 pages

As the swap market continues to grow, it is important for students to understand this market. This note provides a brief history of the swap market, and discusses the conditions under which one would use some of the different types of swaps available. To clarify this discussion several numerical examples are also provided.

Issues: Debt Policy; Derivatives; Risk Management; Financial Strategy
Difficulty: 4 - Undergraduate/MBA

Robert W. White, Paul Noreau, Sandeep Bhargava

Product Number: 9A96B021
Publication Date: 5/14/1996
Revision Date: 2/5/2010
Length: 14 pages

The assistant treasurer of Videotron Ltee (Videotron) pondered over the Citibank proposals that lay on his desk. Videotron was about to launch a US$150 million, 10-year high yield issue in almost a week's time. Since Videotron's business was transacted almost exclusively in Canadian dollars, it would be exposed to foreign exchange risk on the US-dollar denominated interest and principal debt payments. In light of the recent and dramatic depreciation of the Canadian dollar against the U.S. dollar, the treasurer wondered if he should hedge this exposure. The Citibank Canada exposure management team had proposed hedging techniques using either forwards or cross-currency swaps. (A Microsoft Excel spreadsheet is available for use with this case, product 7A96B021.)

Teaching Note: 8A96B21 (281 KB)
Industry: Information, Media & Telecommunications
Issues: Bonds; Derivatives; Risk Management; Hedging
Difficulty: 4 - Undergraduate/MBA

Chapter 8:
Mechanics of Options Markets

Robert W. White, Peter Grosskopf, Linda Atkinson

Product Number: 9A90B050
Publication Date: 1/1/1990
Revision Date: 3/25/2002
Length: 28 pages

The focus of the case is on techniques for hedging gold production. The primary strategy is min/max strategy using over-the-counter gold option contracts. The recent gold price increase from a low of $360 within the year, to a current price of over $394 was making the roll-over decision that much more difficult than if prices had remained stable. The hedging decision involves the quantity of hedges to initiate, the timing of the moves, and the medium through which Barrick could most efficiently make the adjustment. The case permits a discussion of option contracts, forwards and gold loans.

Industry: Mining, Quarrying, and Oil and Gas Extraction
Issues: Financial Strategy; Derivatives; Risk Management; Hedging
Difficulty: 4 - Undergraduate/MBA

Chapter 9:
Properties of Stock Options

Stephen R. Foerster

Product Number: 9A99N009
Publication Date: 4/22/1999
Revision Date: 1/21/2010
Length: 7 pages

An investment advisor for National Securities Inc. was preparing to meet with a client. Based on the advisor's recommendation, the client had previously added an auto parts company to his portfolio of stock investments. Now, as he became more sophisticated, the client wanted to understand the potential benefits and risks of trading call options and put options. This case is the third in a series of three cases that focus on a variety of stock investment decisions. (See 9A99N006 AND 9A99N007.)

Teaching Note: 8A99N09 (6 pages)
Industry: Finance and Insurance
Issues: Investment Analysis; Derivatives; Valuation; Investments
Difficulty: 4 - Undergraduate/MBA

Chapter 10:
Trading Strategies Involving Options

Walid Busaba, Zeigham Khokher, Elliott Weinstein

Product Number: 9B05N012
Publication Date: 8/12/2005
Revision Date: 10/21/2019
Length: 5 pages

The manager of a billion dollar hedge fund had just been approached by a syndicate of funds to gauge her interest in a bid to purchase RamSync Incorporated, a Silicon-Valley manufacturer of memory chips. Using a traditional discounted cash flow analysis (the APV method), the manager quickly determines that at a purchase price of $900 million, RamSync has a negative NPV of $33 million. However, purchasing RamSync, which currently produces SDRAM, would allow the owner to enter the much-anticipated MRAM market at a future period in time. The manager is now forced to reconsider how to value RamSync considering the hidden call option it has on the MRAM market.

Teaching Note: 8B05N12 (4 pages)
Industry: Finance and Insurance
Issues: Options; Options Pricing; Growth Option
Difficulty: 4 - Undergraduate/MBA

Chapter 11:
Introduction to Binomial Trees

Walid Busaba, Zeigham Khokher, Jaclyn Grimshaw

Product Number: 9B05N014
Publication Date: 8/12/2005
Revision Date: 10/4/2009
Length: 12 pages

When valuing the premium to be paid for put or call options, the underlying security is only one of several factors that can determine the option's value. By calculating the impact and value of all the determinants, an option's price more accurately reflects its value. This note examines the effects of various determinants on the price of an option and introduces two models that use options equivalents: the Black-Scholes Option Pricing Model and the Binomial Option Pricing Model.

Issues: Derivatives; Binomial Option Pricing Model; Options Premium; Black-Scholes Formula
Difficulty: 4 - Undergraduate/MBA

Chapter 12:
Valuing Stock Options: The Black-Scholes Model

James E. Hatch, Chris K. Anderson, Soren Milo Christensen, Christen Hagelund

Product Number: 9B04N004
Publication Date: 3/4/2004
Revision Date: 8/8/2005
Length: 12 pages

CNS is a small biotech company. The founder of the company is deciding if it's worth applying for phase I approval that will allow the company to continue its research. He must determine the value of the research. Using the traditional DCF valuation method, he is not sure if this captures all of the value of the research and must decide if either the Black-Scholes or binomial model would more accurately determine the value.

Teaching Note: 8B04N04 (6 pages)
Industry: Manufacturing
Issues: Real Options; Valuation; Data Analysis
Difficulty: 4 - Undergraduate/MBA

Chapter 13:
Options on Stock Indices and Currencies

Robert W. White, K. Scott Dorsey, Bryan Mekechuk

Product Number: 9A96B008
Publication Date: 5/14/1996
Revision Date: 2/5/2010
Length: 17 pages

This case addresses the issues involved with fitting a complex financial instrument to an issuer and an investor. It elicits the participants to consider the unique requirements of issuers and investors and how the features of an instrument fulfil those requirements. The examination of the liquid yield option notes demonstrates that complex instruments can be broken down into a basket of primitive securities to assist the students in understanding the behaviour of the instrument and how it is priced.

Teaching Note: 8A96B08 (227 KB)
Industry: Finance and Insurance
Issues: Derivatives; Innovation; Financial Institutions; Bonds
Difficulty: 4 - Undergraduate/MBA

Robert W. White, Christopher W. Colpitts

Product Number: 9A95B031
Publication Date: 11/7/1996
Revision Date: 2/11/2010
Length: 22 pages

The vice-president of Export Development Corporation is considering an innovative derivative product, Protected Index Notes (PINS) to raise funds. This case introduces students to a major class of financial institutions, export development corporations, that facilitate international trade. As well, this case illustrates the use of SWAP technology to create sub-London Interbank Offered Rate funding with an equity derivative, a note with interest tied to the S & P 500 index.

Teaching Note: 8A95B31 (15 pages)
Industry: Finance and Insurance
Issues: Foreign Exchange; Bonds; Derivatives; Securities
Difficulty: 4 - Undergraduate/MBA

Chapter 14:
Futures Options

James E. Hatch, Manpreet Hora

Product Number: 9B06N017
Publication Date: 10/12/2006
Revision Date: 5/2/2013
Length: 9 pages

The vice-president of finance for Westwood Plastics, Inc. (Westwood), wants to assess the impact of the possibility of a weakening Canadian dollar on the company's financial health given its exposure to the Euro. Because Westwood is required by a loan covenant to generate a minimum level of pre-tax earnings, management is concerned about the possible impact of the exchange rate volatility on projected income and cash flows. The vice-president of finance is considering both an option and a forward strategy to minimize the foreign exchange risk Westwood is facing. She must decide how to use financial instruments to hedge the risk.

Teaching Note: 8B06N17 (22 pages)
Industry: Manufacturing
Issues: Risk Management; Foreign Exchange; Hedging
Difficulty: 4 - Undergraduate/MBA

Chapter 15:
The Greek Letters

Craig Dunbar, Chand Sooran

Product Number: 9A99N010
Publication Date: 6/8/1999
Revision Date: 1/21/2010
Length: 19 pages

IFC Manufacturing, an automobile parts producer, was attempting to raise capital to fund expansion in Mexico. In order to secure financing, the creditor banks required an assessment of the IFC's financial risk management apparatus. IFC had exposures to foreign exchange and interest rates. IFC had grown aggressively by acquiring firms on both sides of the Canadian-U.S. border, funding these purchases in U.S. dollars. The case allows for discussion of a number of issues, including: internal controls (the Group of Thirty recommendations for good derivatives practices), risk measurement and management. Data is provided which allows students to qualify translational and transactional risk exposures. Information is also provided allowing students to evaluate IFC's portfolio of hedging instruments which includes plain vanilla options, single barrier options, double barrier options and average rate options.

Teaching Note: 8A99N10 (14 pages)
Industry: Manufacturing
Issues: Risk Management; Foreign Exchange; Derivatives; Bank Lending
Difficulty: 4 - Undergraduate/MBA

Chapter 16:
Binomial Trees in Practice

Walid Busaba, Zeigham Khokher, Jaclyn Grimshaw

Product Number: 9B05N015
Publication Date: 8/12/2005
Revision Date: 10/4/2009
Length: 8 pages

The real options approach to capital budgeting uses an options-based analysis to evaluate the real (as opposed to the financial) potential of projects. By charting the options as a series of decision points and events, managers can understand the risks and rewards of the projects, and more fully assess their opportunities. This note introduces the real options approach and describes the four main categories: expansion and follow-on options, timing and delay options, abandonment options and options that introduce flexibility into production. The expansion option is discussed in detail, including sample calculations and decision trees.

Issues: Decision Trees; Capital Budgeting; Real Options; Expansion Option
Difficulty: 4 - Undergraduate/MBA

Chapter 17:
Volatility Smiles

Walid Busaba, Zeigham Khokher, Elliott Weinstein

Product Number: 9B05N011
Publication Date: 8/12/2005
Revision Date: 10/4/2009
Length: 6 pages

A first year business school student has obtained a summer job as an analyst at a top investment bank in Los Angeles, California. His first assignment was the pricing of MicroComp's junk-bonds in the market place. Looking at the market value balance sheets, it was very clear that MicroComp was in financial distress. MicroComp's dept totaled $150 million, while the market value of its assets were $80 million. If MicroComp was required to repay its debt immediately, it would be forced into bankruptcy. Clearly, MicroComp was in effective default, why did its market capitalization remain at $5 million? Why had it not fallen to zero? Students will use option theory to answer these questions.

Teaching Note: 8B05N11 (3 pages)
Industry: Finance and Insurance
Issues: Bond Valuation; Put Call Parity; Options Pricing; Volatility
Difficulty: 4 - Undergraduate/MBA

Chapter 18:
Value at Risk

Stephen R. Foerster, Dean Tzembelicos

Product Number: 9A96B056
Publication Date: 10/24/1996
Revision Date: 2/9/2010
Length: 16 pages

The Ontario Teachers' Pension Plan Board, Canada's largest pension fund with over $40 billion in assets, had just listened to a presentation addressing a method for identifying and controlling the pension fund's exposure to market risks known as Value At Risk. The Board needed to understand what Value At Risk represented, what assumptions went into the risk management systems and how it might impact on policy decisions. This case introduces students to the risk management of investment portfolios, highlighting benefits and limitations.

Teaching Note: 8A96B56 (12 pages)
Industry: Finance and Insurance
Issues: Risk Management; Risk Analysis; Pensions; Investments
Difficulty: 4 - Undergraduate/MBA

Chapter 19:
Interest Rate Options

Robert W. White, Neil Rabovsky

Product Number: 9A96B010
Publication Date: 5/14/1996
Revision Date: 2/5/2010
Length: 22 pages

The treasurer of Royal Bank Mortgage Corporation proposes a new residential mortgage product whereby the Royal Bank would use its derivative technology expertise to marry an interest rate cap with a variable rate mortgage. Key issues to be addressed are the design and the demand of the product and the cost to hedge the capped mortgage. As well, the risks and exposures to Royal Bank would require careful consideration before any decision is made.

Teaching Note: 8A96B10 (13 pages)
Industry: Finance and Insurance
Issues: Risk Management; Financial Institutions; Derivatives; Innovation
Difficulty: 4 - Undergraduate/MBA

Robert W. White, Paul R. Badeski

Product Number: 9A87B002
Publication Date: 1/1/1987
Revision Date: 6/3/2003
Length: 16 pages

The executive vice-president of Markborough Properties Inc. was preparing for an upcoming Board of Directors meeting. On the agenda was the proposed use of interest rate hedging to minimize the company's interest rate exposure. Among the alternatives were interest rate swaps and caps. Was it an appropriate time for Markborough to hedge its floating rate debt? If so, how and using what vehicle?

Teaching Note: 8A87B02 (15 pages)
Industry: Real Estate and Rental and Leasing
Issues: Bonds; Bank Lending; Hedging; Risk Management
Difficulty: 4 - Undergraduate/MBA

Chapter 20:
Exotic Options and Other Nonstandard Products

George Athanassakos, Dan Buffery

Product Number: 9B07N011
Publication Date: 10/4/2007
Length: 27 pages

The senior portfolio manager at National Securities Inc. (National) is concerned about the recent decline in shares of Agnico-Eagle Mines Ltd (AEM), a Canadian gold producer with several years of precious metals mining experience that was considered one of the portfolio's strongest performers. The senior portfolio manager and his team recently spent time at one of AEM's mines and believed in the operational potential of the company. National's research department had prepared free cash flow forecasts for AEM, which the senior portfolio manager reviewed and modified, following their visit with the company. He knew that despite his team's belief in the future prospects of AEM, the stock may have become overvalued from a fundamental view point. The senior portfolio manager asked his team to perform a fundamental valuation of the equity of AEM. As normally, this meant the team would use the discounted cash flow (DCF) methodology, with financial assumptions that had been carefully examined. However, he knew that DCF valuation would likely undervalue resource companies, such as AEM, as the DCF valuation tended to overlook the flexibility provided at decision nodes during the life of the company with regards to extracting commodities from the ground. As a result, the senior portfolio manager reminded the team that the DCF method, when applied to a mining company, had to be expanded to explicitly include the value of the un-mined metals. The underground un-mined gold would need to be valued as a real option, using an adjusted Black-Scholes model.

Teaching Note: 8B07N11 (12 pages)
Industry: Mining, Quarrying, and Oil and Gas Extraction
Issues: Cash Flow; Valuation; Real Options; Cash Flow Analysis; Business Valuation
Difficulty: 5 - MBA/Postgraduate

Robert W. White, William Jin

Product Number: 9A99N030
Publication Date: 12/21/1999
Revision Date: 1/21/2010
Length: 24 pages

The corporate governance consultant at the Ontario Municipal Employees Retirement System (OMERS) was preparing to respond to the proxy ballot for resolutions to be voted on at a Royal Oak Mines Inc. shareholders' meeting. Royal Oak's management was requesting that shareholders approve resolutions with respect to the granting of employee stock options (ESO) and the repricing of ESOs. Prior to voting the Royal Oak ESO proxies, OMERS staff wanted to prepare discussion points for a meeting among the portfolio managers, the investment committee, and the corporate governance consultant to review OMERS' position with respect to voting on ESO plans and repricing ESOs. (A Microsoft Excel spreadsheet is available for use with this case, product 7A99N030.)

Teaching Note: 8A99N30 (158 KB)
Industry: Finance and Insurance
Issues: Repricing; Executive Stock Options; Corporate Governance
Difficulty: 5 - MBA/Postgraduate

Chapter 21:
Credit Derivatives

Robert W. White, Christopher C. Corinaldi

Product Number: 9A96B035
Publication Date: 5/15/1996
Revision Date: 2/5/2010
Length: 16 pages

This note includes a discussion of the traditional role of commercial banks, and describes the credit risk management process of assessing credit risk, structuring the credit facility, pricing credit risk, and maintaining the credit facility. It also describes some of the key trends that are changing the nature of commercial banking, and specialized credit products.

Industry: Finance and Insurance
Issues: Credit; Innovation; Deferred Charges; Financial Institutions
Difficulty: 4 - Undergraduate/MBA

Chapter 22:
Weather, Energy, and Insurance Derivatives
Chapter 23:
Derivatives Mishaps and What We Can Learn From Them

Stephen R. Foerster, Dan Chiu

Product Number: 9A96B029
Publication Date: 5/28/1996
Revision Date: 2/5/2010
Length: 17 pages

The focus of this note is to present a risk management framework for current and potential corporate end users of derivatives products in the mid-1990s. Several high profile cases of derivatives problems are presented in the context of the framework. The note also examines where the process has failed and how the failures could have been prevented.

Issues: Risk Analysis; Risk Management
Difficulty: 4 - Undergraduate/MBA