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How to price a basket option where we can sell stock 1 at S1 or Stock 2 at S2 but not both at expiry? The time to expire is 2 months. The risk free rate, volatilities and drifts have been given so is the stock co-relation. Which method would be the best to solve?

Binomial pricing or Monte carlo method?

Binomial method seems a bit tedious.

I am not sure how to implement this in monte carlo method using programming.

I know that monte carlo uses random numbers to find the average of all the outputs.

I would appreciate if anyone could at least guide me through the process and tell me at least which formula to use? Or at least something like an algorithm to solve this problem.

I know that the value of the option would be something like the maximum value of both the stocks but I am not completely clear how to proceed.

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Collen Von
Collen VonLv2
28 Sep 2019

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Employees at D-Bart’s San Jose facility have reason to be concerned. Division Manager Karen Howell received word from headquarters that the San Jose plant would be closed, with operations merged into the San Francisco facility. Most of the San Jose staff would be transferred to San Francisco, since the change was more an effort to save facility costs than to eliminate workers. Even so, approximately 20 percent of the San Jose staff would be let go. Howell was to work with supervisors to decide who would go and who would stay. Since there was no particular area that is to be reduced, Howell thought the most straightforward and equitable method to determine staff cuts was to eliminate 20 percent from each department, with termination decisions based on performance appraisal scores. She has reviewed appraisal records and generated a list of employees she believed should get notice. Howell has not yet shared her list with managers, and no general announcement has been made to employees. Managers have been informed of anticipated cuts and were asked to come up with suggestions on which employees to cut. Howell planned to meet with each department manager to finalize their decisions before they took any action. Howell met with Production Supervisor Dave Bradshaw this morning. They needed to cut five people from his department. Howell and Bradshaw both agreed that reductions would be difficult, but she was surprised when Bradshaw said, “I know this is going to be hard for some people, but it’ll be a good thing, too. I’ve got a couple of people I have wanted to get rid of for a very long time.” “Who’s that?” asked Karen. “Ben Renfro and Jackie Callahan,” Dave said without hesitation. “Why?” asked Karen, “They both have outstanding performance appraisals.” “Well, it doesn’t matter what the paperwork says,” he answered, “they’re both terrible. Renfro’s always wasting time chatting with other employees. He keeps everybody from working, and he never meets production goals. Callahan can’t get to work on time. I bet she’s late three days out of five.” “How do you know she’s late three days out of five?” Karen asked. “Have you kept a log or documented her absence?” “No, but I work with these people. I know what they’re doing. We’re pushed to meet production numbers,” Dave said in his defense. “We don’t have time for that paperwork stuff, and besides, people know they have to be at work on time. If they can’t even do that, we should just get rid of them!” Howell found much the same response from all the managers. It appeared that no one had been taking the appraisal process seriously. Feedback to employees had been haphazard at best, and discipline, if it had occurred at all, had been arbitrary and not properly documented. Managers simply checked off boxes on the appraisal forms so they could get back to the “real” work of production. Howell shook her head. Obviously, the existing performance appraisals could not provide reliable documentation on which to base reduction decisions. She would have to come up with a different plan for appraisals and reducing staff. SHRM is recognized as the source for this case study. Students will complete the assigned case study as a way to increase learning through application of course material in complex, real world situations. To complete the case study the student will:

• Identify and define the central dilemma presented in the case

• Select and gather pertinent areas of consideration, and identify critical data and stakeholders (if you need to make assumptions about any of the facts in the case, be sure to specify these assumptions in your analysis)

• Gather additional information and research as necessary

• Identify and investigate all appropriate possibilities to resolve the central issues, and present at least three different options

• Select and present the best solution and include support for the decision that recognizes positions of all the stakeholders

• Describe how to implement the best solution and include strategies to address the known challenges. Also include the likely implications of the selected solution.

Week 1 Discussion -- Ethical Dilemma

What They Don’t Know Won’t Hurt Them!

Revolutionary Electronic Technologies (RET) recently released anew advanced electronic micro system to be used by financialinstitutions, large corporations, and governments to process andstore financial data, such as taxes and automatic payroll payments.Even though RET developed the technology used in the creation ofthe product, RET’s competitors are expected to possess similartechnology soon. To beat the competition to the market, RETintroduced its new micro system a little earlier than originallyplanned. In fact, laboratory testing had not been fully completedbefore the product reached the market. The tests are complete now,and the final results suggest the micro system might be flawed withrespect to how some data are retrieved and processed. The tests arenot conclusive, though, and even if additional testing proves thata flaw does exist, according to RET, it is of minuscule importancebecause the problem seems to occur for only one out of 100 millionretrieval and processing attempts. The financial ramificationsassociated with the flaw are unknown at this time.

Assume that you are one of RET’s senior executives whose annualsalary is based on the performance of the firm’s common stock. Yourealize that if RET recalls the affected micro system, the stockprice will suffer; thus, your salary for the year will be less thanyou expected. To complicate matters, you just purchased anexpensive house based on your salary expectations for the next fewyears—expectations that will not be realized unless the newmicrosystem is a success for RET.

As one of the senior executives, you will help determinewhat course of action RET will follow with respect to the microsystem. What should you do? Should you encourage RET to recall themicro system until further testing is completed? What other coursesof action do you suggest?

Below is the answer to one of my classmate. I need toresponses something.

Quality of responses to at least two classmates. Saysomething deep & intuitive, don't just rephrase something youread or another student's posting.

Ethics is expressed through a set of rules that have become moreor less explicit following a set of values displayed by thecompany. And then there is the behavioral ethics, specific to theindividual, which is governed by his values, his beliefs, hisconvictions, and who must conform to the professional practicesexpected in his professional environment. Every day, we questionourselves consciously or not about our behaviors but we are alsoconfronted with situations that do not seem to us necessarilyethical ... The human slips so easily under the pressure and theunconscious fears.

As an executive at RET, the ethical thing to do would be toenforce the recall because it will not only keep our integrity tothe eye of the public but also add to our credibility. Money isalways tempting but being a professional requires to make the rightdecision at the right moment. A mistake was made at the beginningbut we need to save the face of the company. It may seem like aloss now but in the long run it will benefit us. As an executive ialways have to prioritize the customer, therefor not selling them afaulty product. In conclusion, personal gratification does notsurpass the company's long term objectives.

You have just completed your undergraduate degree, and one of your favorite courses was "Today's Entrepreneurs." In fact, you enjoyed it so much you have decided you want to "be your own boss." While you were in the program, your grandfather died and left you $300,000 to do with as you please. You are not an inventor, and you do not have a trade skill that you can market; however, you have decided that you would like to purchase at least one established franchise in the fast foods area, maybe two (if profitable). The problem is that you have never been one to stay with any project for too long, so you figure that your time frame is three years. After three years you will sell off your investment and go on to something else. You have narrowed your selection down to two choices; (1) Franchise L: Lisa's Soups, Salads, & Stuff and (2) Franchise S: Sam's Fabulous Fried Chicken. The net cash flows shown below include the price you would receive for selling the franchise in Year 3 and the forecast of how each franchise will do over the three-year period.

Franchise L's cash flows will start off slowly but will increase rather quickly as people become more health conscious, while Franchise S's cash flows will start off high but will trail off as other chicken competitors enter the marketplace and as people become more health conscious and avoid fried foods. Franchise L serves breakfast and lunch, while Franchise S serves only dinner, so it is possible for you to invest in both franchises. You see these franchises as perfect complements to one another: you could attract both the lunch and dinner crowds and the health conscious and not so health conscious crowds without the franchises' directly competing against one another. Here are the net cash flows (in thousands of dollars):

Expected

net cash flows

Year

Franchise S

Franchise L

0

($100)

($100)

1

70

10

2

50

60

3

20

80

Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows.

You also have made subjective risk assessments of each franchise, and concluded that both franchises have risk characteristics that require a return of 10 percent. You must now determine whether one or both of the projects should be accepted.

In order to do so please answer the following questions fully. Make sure to show a time line, the formula to be used, the steps taken to solve the problem (calculator or excel) and the final numerical answer when appropriate.

Questions:

Define the term net present value (NPV).

What is each franchise's NPV? Make sure to show the formula, steps and final answer.

Based on your answer which franchise would you select? Why?

Would your answer be different if the projects are independent or mutually exclusive? Why or why not?

Would the NPVs change, and therefore your answer, if the cost of capital changed? Why or why not?

Internal Rate of Return (IRR) – you may use a financial calculator or excel. (Worth 8 points)

What is the logic/idea behind the IRR method?

Calculate the IRR for each project. Make sure to show the formula, calculator or excel steps and final answer.

According to IRR, which franchise should be accepted if they are independent? Mutually exclusive? Why?

Would the franchises' IRRs change if the cost of capital changed? Why or why not?

Define the term modified IRR (MIRR).

Find the MIRRs for Franchise L and S. Make sure to show the formula, steps and final answer.

What are the MIRR's advantages and disadvantages vis-a-vis the regular IRR? What are the MIRR's advantages and disadvantages vis-a-vis the NPV?

What is the rationale for the payback method?

Calculate the payback period for each franchise. Make sure to show the formula, steps and final answer.

Calculate the discounted payback period for each franchise. Make sure to show the formula, steps and final answer.

According to the payback criterion, which franchise or franchises should be accepted if the firm's maximum acceptable payback is 2 years, and if Franchise L and S are independent? If they are mutually exclusive? Why?

What is the difference between the regular and discounted payback periods? Make sure to mention the advantage and disadvantage of each.

Based on the results obtained and everything that you have described above, which franchise would you ultimately choose if the projects are mutually exclusive? Explain in detail your decision and why you chose the model you did to make your final decision.

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