# Tutorial answers 10 - 2206 AFE Tutorial answers 10 Week 13...

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2206 AFE Tutorial answers 10 Week 13 Questions Chapter 20 Question 1,7, p.840-841 Problems 1, 3, 5 pp.841-844 Chapter 21 Question 3, p.884 Answers Chapter 20 Question 1 (p.840) Since call values are positively related to stock prices while put values are negatively related, any action that causes a decline in stock price (e.g., a dividend) will have a differential impact on calls and puts. Specifically, an impending dividend will boost put values and depress call values. Another way to consider the situation is to represent the difference between the theoretical price of a call option (C) and the theoretical price of a put option (P) as C-P. This is the same as a portfolio that is long a call option and short a put option. For a firm that pays dividends, we expect that the price of its stock will decline by the amount of the dividend on the last day before the stock goes ex-dividend. A decline in stock price makes a call less valuable and a put more valuable, so C-P will decrease. This portfolio has the same payoff as being long a forward contract with a contract price equal to the strike price. Since there is no guarantee that the strike price is the forward price, this forward contract will typically have a non-zero value (i.e. the call and put will have different prices). A dividend will decrease the up-front premium for a long position in a forward contract because the expected stock price at expiration decreases. Consequently, C-P is decreased by dividends. Question 7 (p.840) Call options differ from forward contracts in that calls have unlimited upside potential and limited downside potential, whereas the gains and losses from a forward contract are both unlimited. Therefore, since call options do not have the downside potential of forwards, they represent only the “good half” (the upside potential) of the forward contract. The “bad half” of the long forward position is the unlimited downside potential that is equivalent to being short a put. This is consistent with put-call parity where being long a call and short a put yields the same payoff as a forward contract. Problem 1 (p.841-842) 1(a) (i). A long position in a forward with a contract price of \$50. Expiration Date Sophia Long Forward Initial Long Stock Price (S) (K=\$50) Payoff=S - 50 Forward Premium Net Profit

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25 (\$25.00) \$0.00 (\$25.00) 30 (\$20.00) \$0.00 (\$20.00) 35 (\$15.00) \$0.00 (\$15.00) 40 (\$10.00) \$0.00 (\$10.00) 45 (\$5.00) \$0.00 (\$5.00) 50 \$0.00 \$0.00 \$0.00 55 \$5.00 \$0.00 \$5.00 60 \$10.00 \$0.00 \$10.00 65 \$15.00 \$0.00 \$15.00 70 \$20.00 \$0.00 \$20 00 75 \$25.00 \$0.00 \$25.00 (ii). A long position in a call option with a exercise price of \$50 and a
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## Tutorial answers 10 - 2206 AFE Tutorial answers 10 Week 13...

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