Solution Pages: 3
Files that you will download:
Word (.docx) & Excel (.xlsx)
Questions Covered in the Solution:
Prompt: First, review the case that you have chosen for your final project, as well as the accompanying spreadsheet for the case, and in a 2- to 3-page paper address the following critical elements:
I. Risks and Benefits
- Discuss potential risks and benefits associated with each instrument and how those risks could have an impact on return.
- Assess the impacts of multiple extrinsic and intrinsic factors that the company will want to consider based on how they influence value and price.
II. Price Impact (Spreadsheet Appendix)
- Calculate the potential price impact of extrinsic and intrinsic factors, and expected mitigated risk value of recommended derivative instruments. Present this information in your spreadsheet, and include it as an appendix.
Sample of Solution:
Risks and Benefits
Certainly, there are peculiar risks and benefits associated with each of the derivative instruments (an instrument which has its valued determined by the underlying asset) that may be Mortgage-Backed Security Bonds (MBS Bonds, Subprime Mortgage Bonds) or the Credit Default Swaps (CDS). Since both these instruments are exposed to the risks associated with the underlying assets, their pricing and risk evaluation becomes complex.
Subprime Mortgage Bonds (MBS)
Subprime Mortgage Bonds reflect the mortgage loans on different location-specific properties. Since these bonds and their risks are not potentially associated with the issuing authority rather dependent on the value of properties these bonds are representing. Since, these bonds are different from regular bonds, risk, and benefits associated with such bonds are also more towards the peculiarities of the underlying assets. Whereas, these bonds can allow investors to enter the real estate and the mortgage loan market without actually directly involving with the mortgages and physically buying and selling properties.
Furthermore, investors can use these bonds to invest in the properties from different locations and with different creditworthiness which otherwise not that easy. Consequently, there are also risks associated with such bonds with may extend from uncertain payments to default entirely on the principal payment of bonds. Since these bonds represent the mortgage loans, there is always the risk, the consumers (homeowners; lender) may not make the regular loan payments, or with the shifts in the interest rates, they may choose to make early repayments.