Principles of Corporate Finance
13th Edition
ISBN: 9781260465099
Author: BREALEY, Richard
Publisher: MCGRAW-HILL HIGHER EDUCATION
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Textbook Question
Chapter 20, Problem 23PS
Option values Respond to the following statements.
- a. “I’m a conservative investor. I’d much rather hold a call option on a safe stock like Exxon Mobil than a volatile stock like Amazon.”
- b. “I bought an American call option on Fava Farms stock, with an exercise price of $45 per share and three more months to maturity. Fava Farms’ stock has skyrocketed from $35 to $55 per share, but I’m afraid it will fall back below $45. I’m going to lock in my gain and exercise my call right now.”
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Students have asked these similar questions
Currently you own no stock or options. Today's data for Green Corporation, where the call and put have the same exercise price and expire in one year:
Strike Price Put Price Call Price Stock Price
$32.50 $2.85 $1.65 $30.00
a. If you construct a protective put strategy, which securities will you buy or sell, and what is your total investment today? If the stock price is $20 on the expiration date, what will be the value of your portfolio (payoff) on that day, and your net profit?
b. If you construct a covered call strategy, which securities will you buy or sell, and what is your total investment today? If the stock price is $45 on the expiration date, what will be the value of your portfolio (payoff) on that day, and your net profit?
You have been working as a treasurer at Citibank for the past five years and have previously used swaps, futures, and forward contracts to mitigate risk. However, you have never used options so you are interested in exploring the market. You want to start with small transactions and are considering purchasing a European put on a share for $3. The stock is 42 and the strike price is $40. Furthermore, you are also considering purchasing a call option with the same terms as the put option.
Consider the following question:
Under what circumstances does the investor make a profit? Under what circumstances will the options be exercised? Draw diagrams showing the variation of the investor’s profit.
You work on a proprietary trading desk of a large investment bank, and you have been asked for a quote on the sale of a call option with a strike price of $53 and one year of expiration. The call option would be written on a stock that does not pay a dividend. From your analysis, you expect that the stock will either increase to $73 or decrease to $38 over the next year. The current price of the underlying stock is $53, and the risk-free interest rate is 5% per annum. What is this fair market value for the call option under these conditions? Do not round intermediate calculations. Round your answer to the nearest cent.
$
Chapter 20 Solutions
Principles of Corporate Finance
Ch. 20 - Vocabulary Complete the following passage: A _____...Ch. 20 - Option payoffs Note Figure 20.12 below. Match each...Ch. 20 - Option payoffs Look again at Figure 20.12. It...Ch. 20 - Option payoffs What is a call option worth at...Ch. 20 - Option payoffs The buyer of the call and the...Ch. 20 - Option combinations Suppose that you hold a share...Ch. 20 - Option combinations Dr. Livingstone 1. Presume...Ch. 20 - Option combinations Suppose you buy a one-year...Ch. 20 - Option combinations Suppose that Mr. Colleoni...Ch. 20 - Option combinations Option traders often refer to...
Ch. 20 - Prob. 11PSCh. 20 - Option combinations Discuss briefly the risks and...Ch. 20 - Put-call parity A European call and put option...Ch. 20 - Putcall parity a. If you cant sell a share short,...Ch. 20 - Putcall parity The common stock of Triangular File...Ch. 20 - Put-call parity What is put-call parity and why...Ch. 20 - Putcall parity There is another strategy involving...Ch. 20 - Putcall parity It is possible to buy three-month...Ch. 20 - Putcall parity In April 2017, Facebooks stock...Ch. 20 - Option bounds Pintails stock price is currently...Ch. 20 - Option values How does the price of a call option...Ch. 20 - Option values Respond to the following statements....Ch. 20 - Option values FX Bank has succeeded in hiring ace...Ch. 20 - Option values Is it more valuable to own an option...Ch. 20 - Option values Youve just completed a month-long...Ch. 20 - Option values Table 20.4 lists some prices of...Ch. 20 - Option bounds Problem 21 considered an arbitrage...Ch. 20 - Prob. 30PSCh. 20 - Prob. 31PSCh. 20 - Prob. 32PS
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- You have been working as a treasurer at Citibank for the past five years and have previously used swaps, futures and forward contracts to mitigate risk. However, you have never used options so you are interested in exploring the market. You want to start with small transactions and are considering purchasing a European put on a share for $3. The stock is 42 and the strike price is $40. Furthermore, you are also considering purchasing a call option with the same terms as the put option. Consider the following questions: Under what circumstances does the investor make a profit? Under what circumstances will the options be exercised? Draw diagrams showing the variation of the investor’s profit. Derivatives are zero sum games. Justify the statement with the help of diagramsarrow_forwardSuppose that call options on ExxonMobil stock with time to expiration 3 months and strike price $90 are selling at an implied volatility of 30%. ExxonMobil stock currently is $90 per share, and the risk-free rate is 4%.a. If you believe the true volatility of the stock is 32%, would you want to buy or sell call options?b. Now you need to hedge your option position against changes in the stock price. How many shares of stock will you hold for each option contract purchased or sold?arrow_forwardYou would like to be holding a protective put position on the stock of XYZ Company to lock in a guaranteed minimum value of $108 at year-end. XYZ currently sells for $108. Over the next year, the stock price will increase by 12% or decrease by 12%. The T-bill rate is 4%. Unfortunately, no put options are traded on XYZ Company. Required: a. Suppose the desired put option were traded. How much would it cost to purchase? b. What would have been the cost of the protective put portfolio? c. What portfolio position in stock and T-bills will ensure you a payoff equal to the payoff that would be provided by a protective put with X=108? Show that the payoff to this portfolio and the cost of establishing the portfolio match those of the desired protective put. Complete this question by entering your answers in the tabs below. Required A Required B Required C Suppose the desired put option were traded. How much would it cost to purchase? Note: Do not round intermediate calculations. Round your…arrow_forward
- Stock options, gold options and index options are examples of options where the underlying assets are stocks, gold and stock market index, respectively. What is the difference between European and American option? Are European options available exclusively in Europe and American options available exclusively in the United States? You own a call option on Intuit stock with a strike price of RM36. The option will expire in exactly three months’ time. If the stock is trading at RM46 in three months, what will be the payoff of the call? If the stock is trading at RM32 in three months, what will be the payoff of the call? Draw a payoff diagram showing the value of the call at expiration as a function of the stock price at expiration. Suppose that a June put option to sell a share for RM10 costs RM2 and is held until June. Under what circumstances will the seller of the option make a profit? Under what circumstances will the option exercised?arrow_forwardConsider a stock priced at $30 with a standard deviation of 0.3. The risk-free rate is 0.05. There are put and call options available at exercise prices of 30 and a time to expiration of six months. The calls are priced at $2.89 and the puts cost $2.15. There are no dividends on the stock and the options are European. Assume that all transactions consist of 100 shares or one contract (100 options). Suppose the investor constructed a protective put. At expiration the stock price is $27. What is the investor's profit?arrow_forwardThe stock of Global Consolidated Meganormo Corp. presently sells for $73 per share. You believe that the stock price is likely to drop, and so you buy a $60 put option for 500 shares. The option premium is $2. How will you make out if the stock price drops to (a) $50 and (b) $60arrow_forward
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