Your Aunt Betty has a $120,000 investment portfolio comprising some Government of Canada three-month Treasury Bills and 2,000 Suncor shares. When the portfolio was formed (one month ago), the shares were worth $85,700 and the bonds were worth $34,300. Today, Suncor shares are worth $41.94 per share, while the bond yields have decreased so that the bonds are now worth $38,000. The effective yield on the three-month Canada Treasury Bill is 0.94% per annum. Aunt Betty is a bit concerned about the drop in value of her Suncor shares and consequently, her overall portfolio value. Knowing that you are taking a finance course, she consults you to see what she can do to protect her portfolio from a further drop in value. She has heard a lot about call and put options and would like to know more about these. You immediately go online to look for information on options on Suncor shares. You find the following pricing information on the call options (Table 1) and the put options (Table 2) on Suncor, with expiry in one month: Table 1: Call option prices Strike Last Chg Bid Ask Vol Open Int 41.50 0.43 –0.01 0.42 0.45 98 96 42.00 0.33 +0.13 0.36 0.39 101 38 42.50 0.12 +0.02 0.10 0.16 62 11 43.00 0.05 0.00 0.05 0.08 2 12 Table 2: Put option prices Strike Last Chg Bid Ask Vol Open Int 40.50 0.10 0.00 0.09 0.10 5 5 41.00 0.06 –0.18 0.04 0.06 10 12 41.50 0.13 –0.18 0.10 0.13 48 57 42.00 0.39 –0.48 0.30 0.39 91 1 42.50 1.22 0.00 1.00 1.25 64 64 1)Explain to your Aunt Betty the meanings of call and put options, and how options are different from futures and forward contracts. 2)Looking at all the numbers in the above tables, your Aunt Betty feels very confused. Pick one row from Table 1 (row 2, 3, 4, or 5) and explain what each number across the row means to your Aunt Betty (Strike, Last, Chg, Bid, Ask, Vol, Open Int). 3)Aunt Betty will be retiring in two years. As a result, she is fairly risk-averse when it comes to her investments. She does not like how the recent economic downturn is affecting her portfolio value. However, she would like to hold on to her Suncor shares unless their price falls below $35 per share. Explain to your aunt how she can use the call options to hedge her portfolio against a further drop in Suncor share price.
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
Case 2: Options Case
Your Aunt Betty has a $120,000 investment portfolio comprising some Government of Canada three-month Treasury Bills and 2,000 Suncor shares. When the portfolio was formed (one month ago), the shares were worth $85,700 and the bonds were worth $34,300. Today, Suncor shares are worth $41.94 per share, while the bond yields have decreased so that the bonds are now worth $38,000. The effective yield on the three-month Canada Treasury Bill is 0.94% per annum.
Aunt Betty is a bit concerned about the drop in value of her Suncor shares and consequently, her overall portfolio value. Knowing that you are taking a finance course, she consults you to see what she can do to protect her portfolio from a further drop in value. She has heard a lot about call and put options and would like to know more about these.
You immediately go online to look for information on options on Suncor shares. You find the following pricing information on the call options (Table 1) and the put options (Table 2) on Suncor, with expiry in one month:
Table 1: Call option prices
|
Strike |
Last |
Chg |
Bid |
Ask |
Vol |
Open Int |
|
41.50 |
0.43 |
–0.01 |
0.42 |
0.45 |
98 |
96 |
|
42.00 |
0.33 |
+0.13 |
0.36 |
0.39 |
101 |
38 |
|
42.50 |
0.12 |
+0.02 |
0.10 |
0.16 |
62 |
11 |
|
43.00 |
0.05 |
0.00 |
0.05 |
0.08 |
2 |
12 |
Table 2: Put option prices
|
Strike |
Last |
Chg |
Bid |
Ask |
Vol |
Open Int |
|
40.50 |
0.10 |
0.00 |
0.09 |
0.10 |
5 |
5 |
|
41.00 |
0.06 |
–0.18 |
0.04 |
0.06 |
10 |
12 |
|
41.50 |
0.13 |
–0.18 |
0.10 |
0.13 |
48 |
57 |
|
42.00 |
0.39 |
–0.48 |
0.30 |
0.39 |
91 |
1 |
|
42.50 |
1.22 |
0.00 |
1.00 |
1.25 |
64 |
64 |
1)Explain to your Aunt Betty the meanings of call and put options, and how options are different from futures and forward contracts.
2)Looking at all the numbers in the above tables, your Aunt Betty feels very confused. Pick one row from Table 1 (row 2, 3, 4, or 5) and explain what each number across the row means to your Aunt Betty (Strike, Last, Chg, Bid, Ask, Vol, Open Int).
3)Aunt Betty will be retiring in two years. As a result, she is fairly risk-averse when it comes to her investments. She does not like how the recent economic downturn is affecting her portfolio value. However, she would like to hold on to her Suncor shares unless their price falls below $35 per share. Explain to your aunt how she can use the call options to hedge her portfolio against a further drop in Suncor share price.
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