IPM Problem set 6

IPM Problem set 6 - BUS 415: Investment and Portfolio...

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PROBLEM SET 6 (Team work) Problem 1: Pricing of an option portfolio (20 points) Consider a portfolio that consist of one share of stock XYZ, one unit of a put option written on stock XYZ, and a short position in a call option written on stock XYZ. Both the call and the put options have the same expiration date (1 year from today) and the same strike price ($45). The price of stock XYZ evolves according to a binomial process. The stock is currently trading at $45 and it is known that at the end of one year, the price will be either $60 (in the “up” state) or $30 (in the “down” state). 1. ( 10 points ) What should be the current price of the option portfolio? Assume that the risk-free interest rate is 8% per annum with continuous compounding. 2. ( 10 points ) Using a diagram, show how the net payoff (i.e., the profit/loss) of the option portfolio varies as the stock price at the expiration date varies between $0 and $75. Please, label the axes and the key points in the diagram clearly. Note
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This note was uploaded on 09/25/2011 for the course FINA 4320 taught by Professor John during the Spring '11 term at Houston Baptist.

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IPM Problem set 6 - BUS 415: Investment and Portfolio...

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