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3330_PS10 - Cornell University Gregory Besharov Economics...

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Cornell University Gregory Besharov Economics 3330: Problem Set 10 Due November 17, 2008 1. Suppose you know that a stock, currently at 50, is going to take the value 85 in six months. The standard deviation of the stock is 50% and it pays no dividend. The interest rate is 10%. a. Suppose you can only purchase one call option to express your opinion. It may have any maturity and any integer strike price. What option would you purchase? b. If the cost of the option is determined by the Black-Scholes equation, how much does it cost? c. What is the value of the option you have chosen in six months if the stock takes your predicted price of 85? d. What is the (annualized) return on your investment? What is the net present value of your investment? e. Explain why you have chosen the option you did. 2. In both of the following cases, explain how you as a portfolio manager could use futures to hedge a portfolio. a. You own a large position in a relatively illiquid bond that you wish to sell. b. You will receive a large contribution next month that you hope to invest in long-term corporate bonds on
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