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### ch23_372_2008_exercise

Course: AFM 372, Fall 2009
School: W. Alabama
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Word Count: 222

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parity Put-call example 2 Several years ago, the Australian firm Bond Corporation sold some land that it owned near Rome for \$110 million and as a result boosted its reported earnings for that year by \$74 million. The next year it was revealed that the buyer was given a put option to sell the land back to Bond for \$110 million and also that Bond had paid \$20 million for a call option to repurchase the land for...

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parity Put-call example 2 Several years ago, the Australian firm Bond Corporation sold some land that it owned near Rome for \$110 million and as a result boosted its reported earnings for that year by \$74 million. The next year it was revealed that the buyer was given a put option to sell the land back to Bond for \$110 million and also that Bond had paid \$20 million for a call option to repurchase the land for the same price of \$110 million. 1. What happens if the land is worth more than \$110 million when the options expire? What if it is worth less than \$110 million? 2. Assuming that the options expire in one year, what is interest the rate? 3. Was it misleading to record a profit from selling the land? 1 Solution 1. If the land is worth more than \$110 million, Bond will exercise its call to buy it. If the land is worth less than \$110 million, the land buyer will exercise its put to sell it (to Bond). Either way, Bond will end up owning the land again. 2. Use put-call parity: St + Pt - Ct = Xe-r(T-t) 20 + 110e-r = 110 r = .20 3. Bond will end up owning the land again after the options expire. Bond did not really sell the land and so should not declare a profit from selling it. Bond effectively just borrowed money, it did not sell an asset. 2
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