Finance-Mini Case

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Chapter 8. Mini-Case
Assume that you have just been hired as a financial analyst by Triple Play Inc., a mid-sized California company that specializes in creating high-fashion clothing. Because no one at Triple Play is familiar with the basics of financial options, you have been asked to prepare a brief report that firm’s executives can use to gain a cursory understanding of the topic.
To begin, you gathered some outside materials on the subject and used these materials to draft a list of pertinent questions that need to be answered. In fact, one possible approach to the report is to use a question-and-answer format. Now that the questions have been drafted, you have to develop the answers.
a. What is a financial option? What is the
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How many shares must you buy to create a portfolio with a riskless payoff? What is the payoff of the portfolio?

Hedge portfolio payoff:
- Stock is up:
- Stock is down:
3) What is the present value of the hedge portfolio? What is the value of the call option?
PMT= 0
CPTPV= 12.86


The value of the call option

of riskless payoff

4) What is a replicating portfolio? What is arbitrage?
A replicating portfolio is that in which the portfolio’s payoff is equal to the payoff from the option. Arbitrage is when the investor takes advantage of prices differences without using none of his money, incurs no risk and has no net future obligations.
e. In 1973 Fischer Black and Myron Scholes developed the Black Scholes option pricing model (OPM)

(1) What assumptions underline the OPM?
That the stock pays no dividends, no transaction costs exist, short term risk free rate is known and constant during life of option, it is a European option, short selling is allowed, trading in all securities takes place continuously and stock price moves randomly and buyers of
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