This preview shows pages 1–2. Sign up to view the full content.
Riccardo Colacito
Division of Finance
Problem Set 4
Investments
Due date: April, 8 2010 in class
1. You want to buy a stock that is currently selling for $60. You forecast that in one
year the stock price will be either $110 or $20. There is a one year option on the stock
available with an exercise price of $80. You are able to borrow at a rate of 6.5%. You
would like to hedge your stock position using the call option.
(a) What will be the call’s value if the stock price is $110 in one year? What will be
the call’s value if the stock price is $20 in one year?
(b) What is the hedge ratio you should use?
(c) Assume that you can purchase fractional shares of the stock. How many shares
of the stock would you buy? What position would you take in the option?
(d) What will be the value of your portfolio (combined stock and option position) in
one year if the stock’s price turns out to be $110? What will be the value of your
portfolio if the stock price turns out to be $20?
(e) What is the present value of the amount you found in part d?
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
This is the end of the preview. Sign up
to
access the rest of the document.
 Fall '09
 Strobl

Click to edit the document details