Investments 3.4 March 2010 with answers


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Unformatted text preview: me stock. Writing a covered call is a very safe strategy, as the writer owns the underlying stock. The only risk to the writer is that the stock will be called away, thus limiting the upside potential. 17. All of the following factors affect the price of a stock option except A. the risk‐free rate. B. the riskiness of the stock. C. the time to expiration. D. the expected rate of return on the stock. E. none of the above. 6 A, B, and C are directly related to the price of the option; D does not affect the price of the option. 18. A hedge ratio of 0.70 implies that a hedged portfolio should consist of A. long 0.70 calls for each short stock. B. short 0.70 calls for each long stock. C. long 0.70 shares for each short call. D. long 0.70 shares for each long call. E. none of the above. The hedge ratio is the slope of the option value as a function of the stock value. A slope of 0.70 means that as the stock increases in value by $1, the option increases by approximately$0.70. Thus, for every call written, 0.70 shares of stock would be needed to hedge the investor's portfolio. 19. An American call option buyer on a non‐dividend paying stock will A. always exercise the call as soon as it is in the money. B. only exercise the call when the stock price exceeds the previous high C. never exercise the call early. D. buy an offsetting put whenever the stock price drops below the strike price. E. none of the above. An American call option buyer will not exercise early if the stock does not pay dividends; exercising forfeits the time value. Rather, the option buyer will sell the option to collect both the intrinsic value and the time value. 20. Suppose that the risk‐free rates in the United States and in the United Kingdom are 5% and 4%, respectively. The spot exchange rate between the dollar and the pound is $1.80/BP. What should the futures price of the pound for a one‐year contract be to prevent arbitrage opportunities, ignoring transactions costs. A. $1.62/BP B. $1.72/BP C. $1.82/BP D. $1.92/BP E. none of the above $1.80(1.05/1.04) = $1.82/BP. 7 PART 2 (OPEN QUESTIONS; 6 0 points at maximum) QUESTION 1. (20 points) Equilibrium pricing models Part a. (3 points) Discuss the CAPM vs. the zero‐beta CAPM – give formulas, explain notation and assumptions. Give a graphical interpretation. In what cases is the zero‐beta CAPM used? The zero‐beta CAP...
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