International Financial Management
14th Edition
ISBN: 9780357130698
Author: Madura
Publisher: Cengage
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Given the following data, show the profit from a strategy involving a straddle for the put, call and combined position. The price of a European call and put option are $5 and $6 respectively. Both of the options have a strike price of $30. Explain why a trader might be willing to enter into a straddle.
Please show all work. Please use four decimal places for all calculations.
Your options trading strategy involves buying a European put with a strike price of ₺10 for ₺0.50 and aEuropean call with a strike price of ₺25 for ₺0.75 and selling a European put with a strike price of ₺15 for₺1.25 and a European call with a strike price of ₺20 for ₺1.50. The expiry date and the underlying asset isidentical for each of the four options. Draw the profit diagram for this strategy and indicate the maximumprofit/loss levels and break-even price levels. Show the details of your intermediate calculations.
Adam Smith is a portfolio manager with Point72 Investments, a U.S.-based asset management firm. Smith is considering using options to enhance portfolio returns and control risk. He asks his junior analyst, Tommy Lee, to help him. Lee collected and summarize the relationship between a European call option and various factors that might impact the call option value in Table 1. Which of the relationships shown in Table 1 below is incorrect? (Choose the best answer)
Table 1
Impact of Increasing the Variables on put option value
Variables
Impact on put option value
Stock price
Decrease
Strike Price
Decrease
Maturity
Increase
Volatility
Increase
Interest rate
Decrease
Dividend
Increase
Volatility and Stock Price
Risk-free rate and Volatility
Dividend and stock price
Maturity and Strike Price
Stock Price and Interest Rate
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- Discuss which of the following statements is true. I. An American call option is cheaper than a European call option because we lose the insurance value of the call if we exercise early. II. An American call option is more expensive than a European call option because of the time value of money. III. An American call option is more expensive than an American put option because call options give the right to buy the stock and not to sell it. IV. An American put option is more expensive than a European put option because of the time value of money.arrow_forwardWhich of the following statements is CORRECT? Group of answer choices Call options generally sell at a price greater than their exercise value, and the greater the exercise value, the higher the premium on the option is likely to be. Call options generally sell at a price below their exercise value, and the greater the exercise value, the lower the premium on the option is likely to be. Call options generally sell at a price below their exercise value, and the lower the exercise value, the lower the premium on the option is likely to be. Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock. If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit.arrow_forwardWhich of the following statements is FALSE? A. You invest today only when the NPV of investing today exceeds the value of the option of waiting, which from option pricing theory we know to be always positive. B. When you do not have the option to wait, it is optimal to invest in any positive−NPV project. C. One way to see why you sometimes choose not to invest in a positive−NPV project is to think about the decision of when to invest as a choice between two mutually exclusive projects: (1) invest today or (2) wait. D. When you have the option of deciding when to invest, it is usually optimal to invest only when the NPV is positive but close to zero.arrow_forward
- I posted the question below earlier today, and got an answer that pretty much matched what I had done myself. However, I do have a question. The answer that was provided to me was $3.00 for the common risk-neutral price. When I did the problem myself, I also got $3.00 at one point. But since both the options (down-and-in and down-and-out) have equal risk-neutral prices, don't I have to divide $3.00 by 2 to get $1.50 for the final answer? Hope my question makes sense! Assume a security follows a geometric Brownian motion with volatility parameter sigma=0.2. Assume the initial price of the security is $25 and the interest rate is 0. It is known that the price of a down-and-in barrier option and a down-and-out barrier option with strike price $22 and expiration 30 days have equal risk-neutral prices. Compute this common risk-neutral price.arrow_forward(i)Demonstrate how a bear and a bull spread are created using options and explain the circumstances under which a trader might construct each spread. (ii)Use a numerical example to evaluate the potential payoffs and profits from a strip and a strap combination.arrow_forwardCompared to long hedging, the advantage to using a call option is: A. Call options involve a one-time fixed payment and no need for a margin account B. Call options provide a form of "price insurance" and protect from a worst case scenario C. Call options allow for additional price gains if futures market prices continue to decline D. All the above are advantages to using puts instead of short hedgingarrow_forward
- When the best bid in the market is $23.95 while the best offer or ask is $24.75: A limit sell order at $24.30 will be behind the market. A limit buy order at $19.75 will be aggressively priced. A market sell order at $25.25 will make a new market. A market-if-touched order to buy at $23.25 will make a new market. A limit sell order at $24.15 will make a new marketarrow_forwardCompared to short hedging, the advantage to using a put option is: A. Put options involve a one-time fixed payment and no need for a margin account B. Put options provide a form of "price insurance" and protect from a worst case scenario C. Put options allow for additional price gains if futures market prices continue to increase D. All the above are advantages to using puts instead of short hedgingarrow_forwardOption traders often refer to “straddles”.” Here is an example: ∙ Straddle: Buy one call with exercise price of $100 and simultaneously buy one put with exercise price of $100. Price of the call option is $15 and price of the put option is $10. Draw the position diagram for the straddle.arrow_forward
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