Accounting and Finance.

Balanced scorecard approach:

Under this approach, we shall consider following aspects of performance.

1)      Customer perspective: What the customer value the most? Like cost, quality, time of delivery etc. (customer retention, extension, satisfaction, market share and rate of share growth,

2)      Internal process perspective: To achieve customer and financial perspective, what are the internal processes that entity shall focus more like effectiveness of internal control to avoid errors from being occurred if the customers focused more on the quality of the product more? The factors like rate of the winning the contract, productivity cycle time, cost of reworking on the defective units, effectiveness of the internal controls.

3)      Financial perspective: what the organizations generate for its shareholders? Revenue growth, return on the capital employed, productivity rate, cost control and profitability growth.

4)      Innovative and learning perspective: where we consider that organization must continue to improve and create value. Employee satisfaction, retention, revenue per employee, revenue from sale of new product as compared to last period.

 

Affluent and low income petrol market: under this segment, entity will have following advantaged and disadvantages:

As the consumer growth is more about (4.4%) as compared to low income growth segment which indicates that more new customers can be attracted to use this product or can be switched from the competitor or to persuade the existing customers to use more the existing customers.

However, Due to high prices being offered by us, competitor can gain larger market share.

So,If we prefer low income market segment then due to customer loyalty and low price preferences we can adopt high market share.

 As the consumer income growth is more about (8.3%) as compared to low income growth segment which indicates which indicates that here the customer can afford high prices and are not price conscious due to having higher disposal incomes.

However, as the consumer prefer the technology integration means innovation and unique product that will require higher amount of startup capital that the entity can’t afford due to borrowing limitation.

As the market revenue growth is more about (12.8%) as compared to low income growth segment which indicates that there will be opportunity to capture high revenue in the future

However, as the customers prefers the budgetary friendly fuel product therefore, Affluent market segment may not be successful.:

As the Olium is targeting the middle income groups that prefers the cost effective fuel options, standard vehicle maintenance service and affordable loyalty programs therefore, low income fuel will be preferred.

 

             

Task 3.1

Characteristics of an annuity:

1.      Annuities are utilized when all cash flows are same (in series of payments) with similar interval as well as having more than 1 cash flows to be ascertained at present values or at future values .

2.      Annuities are utilized in assessing the future values with same interest rates as well as with variable interest rates to make decision for long term planning of entities or by persons

In Annuities future values or Present values are calculated for a certain cash flows at a certain time with equal  time difference

But perpetuity are calculated for those cash flows generating for uncertain time period for present values calculations.

 

 Formulas 3. State the formula for the FV of an immediate ordinary annuity.

Future Value in Annuity= Down Payment + Rentals*[((1+Interest rate)^No of years)-1)/(Interest Rate)]

 

4. State the formula for the PV of a growing perpetuity.

Present value of perpetuity=(installment *((1+growth))/(interest rate -growth))

1. In case Mrs. Johnson chooses option 2, how much will she have to pay each month for her loan?

Present Value of Annuity

 

 

Down Payment

150000

Compound Interest Rate

1.50%

No Of months

360

Present Value of Loan Amount

1200000

Interest rate per month

 

0.00125

Present Value in Annuity= Down Payment + Rentals*[((1+Interest rate)^No of years)-1)/(Interest Rate)]

Present Value in annuity               1200000=Rentals*(1-(1+.00125)^-360))/.00125)

 

Loan to be paid each month

                       4141.44

 

 

 

 

 

 

4.      If she chooses option 1,  she  believes she can invest 150,000£ today and in addition, 900£ each month in a financial product that offers 6% return. Assuming she plans to retire in 30 years, how much will she have saved up?

 

Decision Regarding Selection of Option

Description

Values

Future value in case of annuity

 

 

Investment today

 

150000

Installment or Cash Flow each month

900

 Interest Rate

6%

No Of Years

30

No of total months

360

Future Value in Annuity= Down Payment + Rentals*[((1+Interest rate)^No of years)-1)/(Interest Rate)]

Future Value in Annuity

((1+Interest rate)^No of years)-1)/(Interest Rate)]

1004.515042

Future Value in Annuity at his age of retirement

1807449.82

5 Alternatively, if she chooses option 2, she will not be able to invest anything (other than what she invests in her apartment). She believes that the apartment will be worth approximately 1,800,000£ in 30 years at which point she will have no debt. Which options provides the largest savings after 30 years?

Future Value in Annuity

 

((1+Interest rate)^No of years)-1)/(Interest Rate)]

1004.515042

Future Value in Annuity at his age of retirement

1807449.82

 

 

Value of Apartments at 30 years of retirement

1800000

Saving By Investment in product

7449.820047

If She selects option 1 to made investment in the products at rate of 6% return instead of purchase in apartments then she can save the amount (1807449.8-1800000) Rs 7449.8 at her 30 years age

6. Upon retirement she expects to have a yearly cost of living of 37,500£ in year one, which will increase each year by 3.5%. She believes she can continue to grow her investments at an annual return of 5.5%. As she does not know how old she will grow, she would like to assume that she needs payments in perpetuity to never run out of money. Will the two options allow her to live this way?

present value of perpetuity=installment *((1+growth)/(interest rate -growth))

 

 

Installment or Cash Flow each month

 

37500

Installment or Cash Flow each month

4141.44

growth rate

3.5%

Interest rate per annum

5.50%

 

 

 

present value of perpetuity=installment *((1+growth)/(interest rate -growth))

Present value of perpetuity

1940625

 

 

 

7. Mrs. Johnson is somewhat uncertain how long she will stay in London. She is considering moving move outside of the city in 10 years. a. Calculate how much her investment would have grown to if she chooses option 1

Future value in case of annuity

 

 

Investment today

 

150000

Installment or Cash Flow each month

900

 Interest Rate

6%

No Of Years

10

No of total months

 

120

Future Value in Annuity= Down Payment + Rentals*[((1+Interest rate)^No of years)-1)/(Interest Rate)]

Future Value in Annuity

 

 

((1+Interest rate)^No of years)-1)/(Interest Rate)]

163.8793468

 

Future Value in Annuity at his age of retirement

420400.9222

 

 

b. If she chooses option 2, she believes that she would be able to sell the apartment after 10 years and have 375,000£ left after paying the rest of her loan back

Future Value in Annuity at his age of retirement

420400.9222

selling the apartment

375000

Residual amount

45400.92223

 

c. Which option is best with 10-year horizon?

First option will be best as it saves about 45400.33 amount in 10 years horizon of investment to be made

Which indicates that seller will agreed to lend the 1million £ at 3% on September 2024.

ii) If its reasonable certain that 3 months rate in September 2024 is 2% that you would buy the contract because of future contract is priced at interest rate 3% and if the actual interest rate in September 2024 is 2% which is lower than 3% means future contract will be worth more than what you paid for it. The profit in September 2024 would be equal to difference between the future contract interest rate 3% and actual interest rate 2% on notional investment of 1 million £.

iii) A treasurer who is looking to lend 1million £ of funds for 3 months from September 2024 can use future contract to hedge the risk of interest rate fluctuation by selling the contract.

The treasurer will lockup the interest rate in future at which he will lends the fund. If the interest rate fall by September 2024 rate then treasurer will receive the fixed interest rate from future contract. If the rate of interest rises then treasurer will lose on future contract rate but gain on the higher interest rate when lending the funds. Future contracts provides security by hedging against uncertainty of future interest rates.

I)                   The FTSE 100 stock index future contract (5850) is at forward premium due to trading at higher level as compared to Current Cash Index (5800) that case which incurred often where the market is expecting the index to rise in the future. The forward premium is additional return that stakeholders are expected to earn by holding the future contracts instead of underlying cash index in their portfolio.

II)                 To hedge the decline in market by December to 5500, an investor can use the “short” position in FTSE 100 stock index futures which involve selling the future contract at current level 5850 & then purchase back at lower level 5500 to close the position. As a result, gain will be arises equal to the difference in prices of future contracts that will offset any loss arising on investment in FTSE 100 stock. However, the short selling also arises the risk like unlimited downside that need to be done with an appropriate margin and risk management.

III)               If the investor is pessimistic about the market prospects and predict that FTSE 100 stock will be reading 5400 by expiration then a “Short” position in FTSE 100 stock index future to profit from declining market. However such strategy can be used as speculative (as short term investment) comprising of significant amount of risk. As your prediction s based upon the decline in the market and is speculative then your potential loss is theoretically unlimited if the market move is against to you.

1)

Share price (S)

60

Risk free rate of interest ®

10%

Time to Expiration (T)

0.25

Annualized standard deviation

0.4

Variation

0.16

Exercise price (X)

65

 

Using the put Call priority, we can calculate put premium as follows:

                                   

The spot rate on expiry in September 2024 is to be $1.70/£1.

Futures Contracts: A futures contract is an agreement between two parties to buy or sell an asset at a predetermined price and date in the future. In this case, the September 2024 futures contract for the dollar/pound exchange rate has a contract size of £100,000 and a price of $1.60/£1. If you buy a futures contract, you are obligated to buy the underlying asset (in this case, £100,000) at the agreed-upon price ($1.60/£1) on the expiration date (September 2024). If you sell a futures contract, you are obligated to sell the underlying asset at the agreed-upon price on the expiration date.

If the spot rate on expiry is $1.70/£1, you would make a profit if you bought the futures contract because you would be able to buy £100,000 for $160,000 and then sell it for $170,000. Your profit would be $10,000. However, if the spot rate on expiry is lower than $1.60/£1, you would lose money on the futures contract.

Options Contracts: An options contract is similar to a futures contract in that it gives you the right, but not the obligation, to buy or sell an asset at a predetermined price and date in the future. In this case, the September 2024 options contract for the dollar/pound exchange rate has a strike price of $1.60/£1. If you buy a call option, you have the right to buy £100,000 at the strike price of $1.60/£1 on the expiration date. If you buy a put option, you have the right to sell £100,000 at the strike price on the expiration date.

If the spot rate on expiry is $1.70/£1, you would make a profit if you bought a call option because you could buy £100,000 for $160,000 and then sell it for $170,000. Your profit would be $10,000 minus the premium you paid for the call option ($0.04). If you bought a put option, you would not exercise your option because you could sell £100,000 on the open market for $170,000, which is more than the strike price of $1.60/£1. In this case, you would lose the premium you paid for the put option ($0.02).

If the spot rate on expiry is lower than $1.60/£1, you would not exercise your call option because you could buy £100,000 on the open market for less than the strike price of $1.60/£1. In this case, you would lose the premium you paid for the call option. If you bought a put option, you would exercise your option because you could sell £100,000 for more than the market price. Your profit would be the difference between the strike price and the spot rate, minus the premium you paid for the put option.

In general, futures contracts are more risky than options contracts because you are obligated to buy or sell the underlying asset. Options contracts give you the right, but not the obligation, to buy or sell the underlying asset. However, options contracts are more expensive than futures contracts because they give you more flexibility. In this case, if you are confident that the spot rate on expiry will be $1.70/£1, you may want to consider buying a call option because it has the potential for higher profits than a futures contract. However, if you are not as confident in your prediction, you may want to consider a futures contract because it has less risk.

a)      You could buy the call premium at strike price of 300 pence for 610 £ .If the share rises to 400 pence then you will make profit of 390 £ at 500 pence, it will be 1390 £. Even if the share price falls to price like 200 pence then loss is restricted to premium paid of 610 £.

b)      You could buy the put contract at the stake price of 300 pence for 440 £. If the share falls to 200 pence then you can make the profit of 560 £ which will particularly offset the fall in value of your share from 3110 £ to 2000 £, that is, particularly the hedge position worth 2560 £. Should the shares rise to 400 pence then the worth of your share will be 4000 £ & loss of 440 £ from premium giving you a hedge position worth 3560 £.

The Black-Scholes option pricing model is a method for determining the value / premium for European call options. The five determinants of option value according to this model are:

Value of the underlying asset: the price of underlying asset which means dollar per pound exchange rate, is the most important determination of a call premium. As the price of a underlying asset increased to certain degrees, so it has the call premium also increased if the price of underlying asset increased.

Exercise price and time to expiry: The exercise price is the price at which the option can be exercised. The time to expiry is the time remaining until the option expires. As the exercise price increases or the time to expiry decreases, the call premium decreases.

Volatility: Volatility is a measure of the amount by which an asset’s price is expected to fluctuate. As volatility increases, the call premium also increases.

Risk-free rate: The risk-free rate is the rate of return on a risk-free investment, such as a government bond. As the risk-free rate increases, the call premium also increases.

Dividends: Dividends are payments made by a company to its shareholders. In general, dividends decrease the value of a call option. However, this is not a factor in the case of the dollar/pound exchange rate.

The call premium is the price that an investor pays to purchase a call option. According to the Black-Scholes option pricing model, the call premium is determined by the five factors listed above. The model assumes that the underlying asset follows a lognormal distribution and that the option can only be exercised at expiration. The model also assumes that there are no transaction costs or taxes. The Black-Scholes model is widely used by investors and traders to price options and to determine the fair value of an option.

Q no 15:

i. True: The intrinsic value is be calculated as the difference between stock price and the strike price In this case, I intrinsic value is equal to 0 because the stock price is less than the strike price. Their food entire collapse is due to time. Value of option time value is the mode by which the call premium increased the enthusiast value in this case. Time will lose 15 pence, which is greater than the intensive value of 0 pence.

ii. True. The holder of a put option has the right to sell the underlying stock at the exercise price. If the stock price falls below the exercise price, the holder of the put option can sell the stock for more than the market price. Therefore, the holder of the put option breaks even as soon as the stock price falls below the exercise price.

iii. False.

The risk of writing a call option will not be reduced if the writer has short fixed position in underlying stock, in which he is beginning of investment risk is increased or enhance free because the writer is has obligation to sell the stock and exercise price. If the stock price rises above the exercise price, the rider will lose the money on the option

iv. True.

Implied volatility is the measure of market Expectations of future will identify volatility because if the implied volatility rises or increased and other things remain constant. Then call, remember also increased because of that proportional and the probability of the stock price rising increase. The involved and subside price will be increased.  If the employed Volt electricity decrease, then call premium will also be decreased due to probability of stock price rising about the exercise price to decrease.