Management Question

‫المملكة العربية السعودية‬
‫وزارة التعليم‬
‫الجامعة السعودية اإللكترونية‬

Kingdom of Saudi Arabia
Ministry of Education
Saudi Electronic University

College of Administrative and Financial Sciences

Assignment Three
FIN403: Investments
Due Date: 06/12/2025 @ 23:59
Student’s Name: Ali Alyami
Abdulrahman Semaida
Abdulkarim Mulla

Course Name: Investments

Abdullah Alsubaie
Salman Almehisen
Student’s ID Number: S220039291
S220020088
Course Code: FIN403

S220047913
S210050517
S220013590

Semester: First

CRN:12691
Academic Year:2025-2026

For Instructor’s Use only
Instructor’s Name: Dr. Muath Alolayan
Students’ Grade: Marks Obtained/Out of 20

Level of Marks: High/Middle/Low

General Instructions – PLEASE READ THEM CAREFULLY
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The Assignment must be submitted on Blackboard (WORD format only) via allocated
folder.
Assignments submitted through email will not be accepted.
Students are advised to make their work clear and well presented; marks may be reduced
for poor presentation. This includes filling in your information on the cover page.
Students must mention question numbers clearly in their answer.

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Late submission will NOT be accepted.
Avoid plagiarism, the work should be in your own words, copying from students or other
resources without proper referencing will result in ZERO marks. No exceptions.
All answers must be typed using Times New Roman (size 12, double-spaced) font. No
pictures containing text will be accepted and will be considered plagiarism).
Submissions without this cover page will NOT be accepted.

Learning Outcomes:
After completion of Assignment three students will be able to understand the following

CLO4:Demonstrate the valuation methods used for the valuation of the common forms
of debt, equity, property, and derivative securities.
CLO5:Illustrate asset models of a stochastic nature that are appropriate to the
management of liabilities.

Assignment Questions (5 marks each ):
1. Should an investor who thinks interest rates are going down seek low or high
coupon rate bonds? Relate your answer to duration and price sensitivity.
2. Why do investors tend to pay a smaller premium for a warrant as the price of the
stock goes up?
3. Assume you wish to control the price movement of 100 shares of stock. You may
buy 100 shares of stock directly or purchase a call option on the 100 shares.
Which strategy is likely to expose you to the larger potential dollar amount of
loss? Which strategy is likely to expose you to the larger potential percent loss on
your investment?
4. How can using the financial futures markets for interest rates and foreign
exchange help financial managers through hedging? Briefly explain and give one
example of each.
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Answers
1. Should an investor who thinks interest rates are going down seek low or highcoupon-rate bonds? Relate your answer to duration and price sensitivity.
A bond investor anticipating interest rates to fall must purchase low-coupon bonds,
as most of them are longer and hence are more impacted by a shift in interest rates. Duration
refers to the scale of the movement of the price of a bond in response to changes in the
rates; long duration means that the price of a bond will respond more to a decline in the
rates. The coupon of low-coupon bonds collects a significant amount of cash flow during
the maturity, and this keeps the investors waiting longer to recoup the investment, thus
making them more sensitive. This implies that as the rates fall, the low-coupon bonds will
increase in price by much more than the high-coupon bonds. In a market where interest
rates are declining and the investor is interested in capital gains maximization, a longduration low-coupon bond needs to be the answer.
An example of this is that when interest rates are low, such as 1 percent, a lowcoupon bond of 10 years could gain price by approximately 10, and a high-coupon bond
of six years would gain price by 6 only. It is due to the fact that high-coupon bonds earn
more interest in the short run, which means that future cash flows of bonds are less timesensitive and that they have a shorter duration. Though high-coupon bonds yield more
intact income, they just do not gain as much on the declining interest rates (Janus, 2021).
So, investors who are expecting low rates ought to invest in long-duration low-coupon
bonds in a strategic manner to ensure higher price gains. In fixed-income portfolio
management, this method is usually employed to exploit interest rate cycles.

2. Why do investors tend to pay a smaller premium for a warrant as the price of the
stock goes up?
A lower price is paid by investors on a warrant for the increase in price of the stock
because the time value of a warrant is less compared to the intrinsic value of the stock. A
warrant entitles the holder of the warrant to purchase the stock at a given exercise price;
therefore, when the stock appreciates significantly higher than the exercise price, then a
large part of the value of the warrant is intrinsic, not speculative. The higher the price of
the stock, the less predictable are the chances of any additional dramatic gains, particularly
in stable or mature firms. The higher the large premium over intrinsic value, the less willing
investors are to pay it since the potential of high upside is perceived to be reduced.
Consequently, the premium would go down despite the possibility that the total value of
the warrant would still go up.
In an example, suppose that a warrant allows an investor to purchase a stock at a
price of $50. At a sustainable level of stock price between $55 $80, there is an increase in
intrinsic value, which is 5 to 30. Although this does not render the warrant useless,
investors perceive a risk of additional dramatic gains as lesser by greater prices. With a
premium representing projections of volatility and future increase, the premium part
becomes unjustified after the stock has become costly. The warrant is transformed into an
even more direct equivalent to holding the stock, and lowers the readiness of investors to
pay a premium. As such, whilst the intrinsic component increases, the premium will
automatically compress due to reduced expectations of exceptional future returns.
3. Assume you wish to control the price movement of 100 shares of stock. You may
buy 100 shares of stock directly or purchase a call option on the 100 shares. Which

strategy is likely to expose you to the larger potential dollar amount of loss? Which
strategy is likely to expose you to the larger potential percentage loss on your
investment?
When an investor purchases 100 shares, the direct effect of this purchase is a
significant dollar loss on a much greater scale, since the invested amount of money is at
risk. By way of illustration, an investor could purchase 100 shares at $50 a piece, which is
an investment of $5000. In the event of bankruptcy of the company, where the stock price
reaches an all-time low, then the entire sum of money in the form of the stock is lost. Stocks
have limitless potential for increase, and this is subject to the risk of a significant loss of
absolute capital. This is due to the fact that holding shares is a complete ownership of the
underlying commodity, and the dollar loss is a direct reversion of the dollar change in the
value of said commodity (Pan, 2024). Accordingly, a purchase of the actual shares will in
all cases have a greater potential dollar loss than a purchase of an option.
On the flipside, purchasing a call option has a higher percentage of loss when
compared to purchasing a put option, despite the fact that the overall dollar loss remains
low. A call option would just need the payment of a premium that could be a minimal
percentage of the stock price. As an example, when an investor spends 300 dollars on a
call option and this option becomes worthless in the end, this represents a 100 percent loss.
The dollar loss is, however, limited to 300 dollars. This is to emphasize the leveraged
quality of options: the payoff of the investment in comparison to the investment itself can
be huge or very low. In this way, although shares bear a greater dollar risk, call options
bear an enormous percentage risk in regard to the money invested.

4. How can using the financial futures markets for interest rates and foreign exchange
help financial managers through hedging? Briefly explain and give one example of
each.
Financial futures also assist managers to hedge the interest rate risk as they can lock
the interest rates they are borrowing or investing in, so that the company is not affected by
a negative change in the interest rates. One such thing is that a company that intends to
issue bonds in a matter of six months may be worried that the interest rates will increase,
thus making it more costly to borrow money. The manager can sell interest rate futures in
order to hedge this risk. In case the interest rates rise, the borrowing costs of the firm
increase, but the futures position also increases in value, overriding the loss. This allows
financing costs to be stabilized in the company and allows long-term planning with more
certain costs. The interest rate futures are also popular in dealing with rate risks in areas
where one has to borrow a lot of money.
Currency risk is also met with the foreign exchange futures. An international
company can get payment in another currency months after a sale. When the euro
depreciates prior to the payment date, the company will get less money in terms of
converting to its home currency. To avoid this, the manager will be able to sell euro futures
to secure the current exchange rate. In cases where the euro affects the futures positively
in the future, the conversion value loss will be compensated by a gain in the futures position
(Li & Lu, 2022). This guarantees consistency in cash flows, guards the profit margins, and
drives away uncertainty due to fluctuating exchange rates. Through financial futures,
companies are in a position to hedge as they work in more secure global markets.

References
Janus, J. (2021). The COVID-19 shock and long-term interest rates in emerging market
economies.

Finance

Research

Letters,

101976.

Li, X., & Lu, Y. (2022). Research on Interest Rate Risk Management Based on Duration,
Convexity, and Immunization. BCP Business & Management, 26, 356–364.

Pan, Y. (2024). Hedging Strategies with Derivatives after 2020. Highlights in Business,
Economics and Management, 24, 2407–2415.

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