The common stock of Sophia Enterprises serves as the underlying asset for the following derivative securities: (1) forward contracts, (2) European-style call options, and (3) European-style put options. a. Assuming that all Sophia derivatives expire at the same date in the future, complete a table similar to the following for each of the following contract positions: (1) A long position in a forward with a contract price of $50 (2) A long position in a call option with an exercise price of $50 and a front-end premium expense of $5.20 Expiration Date Sophia Stock Price Expiration Date Derivative Payoff Initial Derivative Premium Net Profit 25 30 35 40 45 50 55 60 65 70 75 (3) A short position in a call option with an exercise price of $50 and a front-end premium receipt of $5.20 In calculating net profit, ignore the time differential between the initial derivative expense or receipt and the terminal payoff. b. Graph the net profit for each of the three derivative positions, using net profit on the vertical axis and Sophia's expiration date stock price on the horizontal axis. Label the breakeven (zero profit) point(s) on each graph. c. Briefly describe the belief about the expiration date price of Sophia stock that an investor using each of these three positions implicitly holds.

Financial Reporting, Financial Statement Analysis and Valuation

8th Edition

ISBN:9781285190907

Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Publisher:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Chapter7: Financial Activities

Section: Chapter Questions

Problem 15QE

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The common stock of Sophia Enterprises serves as the underlying asset for the following derivative securities: (1) forward contracts, (2) European-style call options, and (3) European-style put options.

a. Assuming that all Sophia derivatives expire at the same date in the future, complete a table similar to the following for each of the following contract positions:

	(1) A long position in a forward with a contract price of $50
	(2) A long position in a call option with an exercise price of $50 and a front-end premium expense of $5.20

Expiration Date Sophia Stock Price	Expiration Date Derivative Payoff	Initial Derivative Premium	Net Profit
25
30
35
40
45
50
55
60
65
70
75

	(3) A short position in a call option with an exercise price of $50 and a front-end premium receipt of $5.20
	In calculating net profit, ignore the time differential between the initial derivative expense or receipt and the terminal payoff.

b. Graph the net profit for each of the three derivative positions, using net profit on the vertical axis and Sophia's expiration date stock price on the horizontal axis. Label the breakeven (zero profit) point(s) on each graph.

c. Briefly describe the belief about the expiration date price of Sophia stock that an investor using each of these three positions implicitly holds.

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