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PS7Solutions_09

PS7Solutions_09 - Solution to Problem Set 7 Investments...

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Solution to Problem Set 7 Investments Prof. Pierre-Olivier Weill 1. An investor wants to capture profits if Microsoft declines in price but wants loss no greater than $10 if prices increase. Only one transaction is permitted. Solution: The investor should buy an “at the money” put ( X = $100) for $10, which produces the following profit table: Stock price 50 60 70 80 90 100 110 120 130 140 150 Payoff 50 40 30 20 10 0 0 0 0 0 0 Profit 40 30 20 10 0 -10 -10 -10 -10 -10 -10 2. An investor just bought Microsoft for $100 and wants to protect against price declines but wants to retain upside if prices rise. Only one additional transaction is permitted here. Solution: The investor should add to his portfolio an “at the money” put ( X = $100) for $10, which produces the following profit table (taking into account the price you paid for the stock at the beginning): Stock price 50 60 70 80 90 100 110 120 130 140 150 Payoff 100 100 100 100 100 100 110 120 130 140 150 Profit -10 -10 -10 -10 -10 -10 0 10 20 30 40 3. An investor wants upside potential if Microsoft increases but wants (net) losses no greater than $10 if prices decline. Only one transaction is permitted.
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