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[answered] 1)A stock sells for $60 and the risk-free rate of interest


  • 1)A stock sells for $60 and the risk-free rate of interest is 10%. A call and a put on this stock expire in one year and both options have an exercise price of $55. How would you trade to create a synthetic call option? If the put sells for $2, how much is the call option worth? (Assume annual compounding.) (Points : 30

    2)What is the relationship between the risk of the underlying stock and the call price? Explain in intuitive terms.

    3)A long-time client, an insurance salesperson, has noticed the increased acquisition activity involving commercial banks. Your client wishes to capitalize on the potential gains associated with this increased acquisition activity in the banking industry by creating speculative positions using options. Your client realizes that bank cash flows are sensitive to changes in interest rates, and he/she believes that the Federal Reserve is about to increase short-term interest rates. Realizing that an increase in the short-term interest rates will lead to a decrease in the stock prices of commercial banks, your client wants the value of his/her portfolio of options to be unaffected by changes in short-term interest rates. Explain how the investor can use option contracts to protect his/her portfolio against changes in value due to changes in the risk-free rate, and to capitalize on the expected price changes in bank stocks. (Points : 30)

    4) Explain the difference between pure and quasiarbitrage. (Points : 30)

    5) Describe the difference between a stack hedge and a strip hedge. What are the advantages and disadvantages of each? (Points : 30)

    6)The S&P 500 futures contract is scheduled to expire in half a year, and the interest rate for carrying stocks over that period is 8%. The expected dividend rate on the underlying stocks for the same period is 2% of the value of the stocks (the 2% is the half-year rate, not an annual rate). Ignoring the interest that it might be possible to earn on the dividend payments, find the fair value for the futures if the current value of the index is 970.00. (Points : 30)

    7) The spot value of the euro is $1.50, and the 90-day forward rate is $1.45. If the U.S. dollar interest factor to cover this period is 2%, what is the EMU rate for this period?(Points : 30)

    8) The IMM Index stands as 93.30. What is the discount yield? If you buy a T-bill futures at that index value and the index becomes 92.90, what is your gain or loss?(Points : 30)

    9) When a house is purchased, the contract is signed first and the closing is expected weeks later. At the closing, the buyer pays the seller for the house and the buyer takes possession. Explain how this transaction is like a futures or forward transaction. (Points : 30)

    10) Consider a firm financed solely by common stock and a single callable bond issue. Assume that the bond is a pure discount bond. Is there any circumstance in which the firm should call the bond before the maturity date? Would such an exercise of the firm?s call option discard the time premium? Explain. (Points : 30)


1. The following formula should apply: Therefore, with the information given: S= $60

 

P= $2

 

r= 11%

 

C= $60+$2- 55$/(1+10%)^1

 

C= $62- $50 = $12 2. The relationship between the risk of the underlying...

 


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