Could you please help me solve this task :)? I am struggling with it.
Heidi Nordstrom is a fund manager for a swedish fund that invests in large cap equities on the exchange in stockholm. The fund management company charges its clients two fees: one fee is fixed in relation to invested capital and one fee is variable in relation to the net income of the fund. The fund charges 2% on the capital of the fund and 20% on returns. (This is often referred to as a 2+20 fee structure) Nordstrom assesses the situation the month before the fees are to be charged. The fund’s equity positions at that time exactly match a broad index of Swedish shares, the OMX Stockholm 30 index (OMXS30). In fact the variable fee has a relation of 1:1 with the index return at the current index price. The variable fee is to be charged by the fund company on the same date as the next option expiration date. The returns of the fund have been good so far, and the variable fee alone would be 10 million Swedish krona had the fee been paid today.
1. The risk manager at the fund management company has also been looking at the position of Nordstrom. He has a different view on the position. The risk manager concludes that if the Swedish index would decrease from its current level by 10% or more, the variable fee would be zero. The risk manager gives Nordstrom the (in)famous “shoulder tap” and asks for the following:
a. An analysis of the strategic choices available to the fund company to manage the variable fee.
b. A graph of the profit as a function of underlying index as of the next expiration date. Explain the details of the graph carefully. What type of instrument does the pay-off function resemble?
Fortunately, the index is very well traded and there is an active electronic market for the derivatives of the index.
2. Find quotes for options that expire at the next expiration date from the NasdaqOMX (www.nasdaqomxnordic.com). Navigate using the “options and futures” tab and then search for “index options and futures”. When you have identified the OMXS30, use the filter function to get the quotes for the next expiration date.
a. Identify the futures price for the OMXS30 index, perhaps using the filter function. A future is an agreement to buy the underlying asset where payment is delayed until a future date. Calculate the number of futures contracts that correspond to as position of 10 million Swedish krona.
b. Nordstrom finds that the entire market risk can be canceled by selling call options. Identify the call option that has a strike price closest to a 10% decrease in index value. Determine how much Nordstrom would receive in fees if she issued the number of call contracts identified in part a. on the bid price. How many options does Nordstrom need to sell to hedge her position?
c. If Nordstrom instead had been able to issue calls on the ask price, how much money would she have received.
d. Compute the overall profit/loss at the expiration date if:
– The OMXS30 is trading at the same price as identified in part a.
– The OMXS30 is trading at a price 10% below the price as identified in part a.
3. Just when Nordstrom is about to execute the trade suggested, she realizes that there is actually another way of hedging her risk using two trades in other instruments.
a. How could Nordstrom hedge her risk without using the call options in question 2?
b. What trades should she execute if she is not issuing call options?
c. Compute the overall profit/loss if:
– The OMXS30 is trading at the same price as identified in part a at the expiration date.
– The OMXS30 is trading at a price 10% below the price as identified in part a at the expiration date.
4. Do the two strategies protect Nordstrom from losing the accrued variable fee? Which one do you prefer and why.
5. By issuing call options, Nordstrom eliminates her risk in relation to the fund. Would you consider that there is a potential agency conflict between Nordstrom and the fund investor?
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