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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

OPTIONS Audrey is considering an investment in Morgan Communications, whose stock currently sells for $60. A put option on Morgan’s stock, with an exercise price of $55, has a market value of $3.06. Meanwhile, a call option on the stock with the same exercise price and time until expiration has a market value of $9.29. The market believes that at the expiration of the options, the stock price will be $50 or $70 with equal probability.

  1. a. What is the premium associated with the put option? The call option?
  2. b. If Morgan’s stock price increases to $70, what would be the return to an investor who bought a share of the stock? If the investor bought a call option on the stock? If the investor bought a put option on the stock?
  3. c. If Morgan’s stock price decreases to $50, what would be the return to an investor who bought a share of the stock? If the investor bought a call option on the stock? If the investor bought a put option on the stock?
  4. d. If Audrey buys 0.6 share of Morgan Communications and sells one call option on the stock, has she created a riskless hedged investment? What is the total value of her portfolio under each scenario?
  5. e. If Audrey buys 0.75 share of Morgan Communications and sells one call option on the stock, has she created a riskless hedged investment? What is the total value of her portfolio under each scenario?

a.

Summary Introduction

To determine: The premium related with the call and put option.

Introduction:

Option is a contract to purchase a financial asset from one party and sell it to another party on an agreed price for a future date. There are two types of options, which are as follows:

  • Call option
  • Put option
Explanation

Given information:

Person A has invested in the M Company. The company’s stock price is $60. The put option has an exercise price is $55 and the market value is $3.06. Even the call option has the same exercise price and market value is $9.29 until the time of expiry. The stock price might be $50 or $70 with equal chance.

The formula to compute the exercise value is as follows:

Exercise value=Current stock priceExercise price

Compute the current exercise value of put option:

The table below shows the Excel formula to calculate the current exercise value of put option:

The table below shows the calculated values of the current exercise value of put option:

b.

Summary Introduction

To determine: The return to an investor who own stock, buy call option, and buy put option.

Introduction:

An option where the investor buys an asset called call option and an option where the investor sells an asset called put option.

c.

Summary Introduction

To determine: The return to an investor who own stock, buy call option, and buy put option.

d.

Summary Introduction

To determine: The total value of portfolio of Person A in each scenario.

e.

Summary Introduction

To determine: The total value of portfolio of Person A in each scenario.

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