CHAPTER 1
Introduction
Practice Questions
Problem 1.8.
Suppose you own 5,000 shares that are worth $25 each. How can put options be used to provide you with insurance against a decline in the value of your holding over the next four months?
You should buy 50 put option contracts (each on 100 shares) with a strike price of $25 and an expiration date in four months. If at the end of four months the stock price proves to be less than $25, you can exercise the options and sell the shares for $25 each.
Problem 1.9.
A stock when it is first issued provides funds for a company. Is the same true of an exchange-traded stock option? Discuss.
An exchange-traded stock option provides no funds for the company. It is a security
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The profit as a function of the stock price is shown in Figure S1.1.
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Figure S1.1 Profit from long position in Problem 1.13
Problem 1.14.
Suppose that a June put option on a stock with a strike price of $60 costs $4 and is held until June. Under what circumstances will the holder of the option make a gain? Under what circumstances will the option be exercised? Draw a diagram showing how the profit on a short position in the option depends on the stock price at the maturity of the option.
The seller of the option will lose if the price of the stock is below $56.00 in June. (This ignores the time value of money.) The option will be exercised if the price of the stock is below $60.00 in June. The profit as a function of the stock price is shown in Figure S1.2.
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Figure S1.2 Profit from short position In Problem 1.1
Problem 1.15.
It is May and a trader writes a September call option with a strike price of $20. The stock price is $18, and the option price is $2. Describe the investor’s cash flows if the option is held until September and the stock price is $25 at this time.
The trader has an inflow of $2 in May and an outflow of $5 in September. The $2 is the cash received from the sale of the option. The $5 is the result of the option being exercised. The investor has to buy the stock for $25 in September and sell it to the purchaser of the option for $20.
Problem 1.16.
An investor writes a December put
b. The optimal transfer price is $0.99, giving a buy-back price of $0.988, and channel profits of $372.62. However, this is an unrealistic scenario because Ralph’s profits are negative at -$24 and
The seller of the option will lose if the price of the stock is below $56.00 in June. (This ignores the time value of money.) The option will be exercised if the price of the stock is below $60.00 in June. The profit as a function of the stock price is shown in Figure S1.2.
* With the event “March 10” – according to the schedule Dhawan expects, we face situation like question 1, no delay or delay. To avoid repeating, we use the result of question 1, Dhawan will receive profit 207,084 INR if it is delivered on March 10.
The Bank War was the name given to the campaign begun by President Andrew Jackson in 1833 to destroy the Second Bank of the United States. The Second Bank had been established in 1816, as a successor to the First Bank of the United States, whose charter had been permitted to expire in 1811. In the veto message, President Jackson eagerly rejects a bill that leased the Bank of the United States. He argues that the Bank gives privilege and unfair advantage to a wealthy few at the expense of the public, and he opposes foreign ownership of Bank stock. The President claims the same right to interpret the Constitution as Congress and the Supreme Court when he questions the constitutionality of the Bank. The bank’s charter was unfair, Jackson argued in his veto message, that the bank was given significantly to much market power, specifically in the markets that moved financial properties from place to place in the country and into and out of additional nations. That market power enlarged the bank’s revenues and consequently its stock price, “which operated as a gratuity of many millions of dollars to the stockholders,”. Jackson proposed that it would be reasonable to the majority of
13. What is the formula for the Present Value (PV) for a finite stream of cash flows (1 per year) that lasts for 10 years?
1. Consider the $50,000 excess cash. Assume that Gary invests the funds in one-year CD.
c) The present value of $500 to be received in one year when the opportunity cost rate is 8 percent (discounting):
1. Ignoring taxation and other constraints, Ms. Jameson is better off taking the options. The stock currently trading at $18.75 and the exercise price is $35. This may seem drastically far away. However, 5 year T-Bill rates are currently at 6.02%. Combined with a current stock volatility of approximately 42%, this allows each option to be valued at approximately $4.93.
The statement of cash flows answers the following questions about cash: (a) Where did the cash come from during the period? (b) What
1) Put option to sell British pounds for $1.50/£ expiring in March with a premium of $.056/£.
Stock options and warrants give the holder the right to purchase a share of stock at a predetermined price within a given time period. According to Richard G Schroeder in the textbook Financial Accounting Theory and Analysis: Text and Cases, under current GAAP the cash inflow received from these securities needs to be reported as equity. The value reported in subsequent periods is historical and does not change in response to changes in the market value of these securities.
FAS 123(R) 5 states that an entity should recognize services received in a share based payment transaction when those services are received. 10 states that an entity shall account for compensation cost from share-based payment transactions with employees in accordance with the fair-value-based method. Under the fair-value-based method, the cost of services received from employees in exchange for awards of share-based compensation shall be measured based on the grant-date fair value of the equity instruments issued. A10-A17 discuss the acceptable methods of calculating fair value at the grant date. The grant-date fair value of the Murray options is $6. Following the guidance in Illustration 4(a), Share Options with Cliff Vesting, of FAS 123(R), compensation expense for the years ended December 31, 2006 & 2007 is $200,000 per year (calculation attached hereto).
Question 2: Assume that Jim is subject to a $5,000,000 position limit. What position should he take to exploit the mispricing for the March '86 MMI futures?
The net present value (NPV) of each option has been calculated and included in Table 1, based on figures from the study group report. Unfortunately, these figures are flawed in the same manner as Wriston’s current performance and accounting mechanisms in that they don’t properly allocate revenue, nor do they recognize inherent manufacturing complexities. The plant closure option’s expected operational gain seems particularly suspect. A better valuation of the new plant options is perhaps
1. Identify the steps taken by Menton Bank to develop a stronger customer orientation in its retail branches.