Alternatively one might view the bondholders as

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Alternatively, one might view the bondholders as giving the right to the equity holders to reclaim the firm by paying off the B dollar debt. The bondholders have issued a call to the equity holders. 14. The manager gets a bonus if the stock price exceeds a certain value and gets nothing otherwise. This is the same as the payoff to a call option. 20-8
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Spreadsheet for Problem 11: Stock Prices Beginning Market Price 116.5 Ending Market Price 130 X 130 Straddle Ending Profit Buying Options: Stock Price -37.20 Call Options Strike Price Payoff Profit Return % 50 42.80 110 22.80 20.00 -2.80 -12.28% 60 32.80 120 16.80 10.00 -6.80 -40.48% 70 22.80 130 13.60 0.00 -13.60 -100.00% 80 12.80 140 10.30 0.00 -10.30 -100.00% 90 2.80 100 -7.20 Put Options Strike Price Payoff Profit Return % 110 -17.20 110 12.60 0.00 -12.60 -100.00% 120 -27.20 120 17.20 0.00 -17.20 -100.00% 130 -37.20 130 23.60 0.00 -23.60 -100.00% 140 -27.20 140 30.50 10.00 -20.50 -67.21% 150 -17.20 160 -7.20 Straddle Price Payoff Profit Return % 170 2.80 110 35.40 20.00 -15.40 -43.50% 180 12.80 120 34.00 10.00 -24.00 -70.59% 190 22.80 130 37.20 0.00 -37.20 -100.00% 200 32.80 140 40.80 10.00 -30.80 -75.49% 210 42.80 Selling Options: Bullish Call Options Strike Price Payoff Profit Return % Ending Spread 110 22.80 -20 2.80 12.28% Stock Price 6.80 120 16.80 -10 6.80 40.48% 50 -3.2 130 13.60 0 13.60 100.00% 60 -3.2 140 10.30 0 10.30 100.00% 70 -3.2 80 -3.2 Put Options Strike Price Payoff Profit Return % 90 -3.2 110 12.60 0 12.60 100.00% 100 -3.2 120 17.20 0 17.20 100.00% 110 -3.2 130 23.60 0 23.60 100.00% 120 -3.2 140 30.50 10 40.50 132.79% 130 6.8 140 6.8 Money Spread Price Payoff Profit 150 6.8 Bullish Spread 160 6.8 Purchase 120 Call 16.80 10.00 -6.80 170 6.8 Sell 130 Call 13.60 0 13.60 180 6.8 Combined Profit 10.00 6.80 190 6.8 200 6.8 210 6.8 20-9
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20-10
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Profit diagram for problem 11: -50.00 -40.00 -30.00 -20.00 -10.00 0.00 10.00 20.00 30.00 40.00 50.00 0 50 100 150 200 250 130 Straddle Bullish Spread 15. i. Equity index-linked note: Unlike traditional debt securities that pay a scheduled rate of coupon interest on a periodic basis and the par amount of principal at maturity, the equity index-linked note typically pays little or no coupon interest; at maturity, however, a unit holder receives the original issue price plus a supplemental redemption amount, the value of which depends on where the equity index settled relative to a predetermined initial level. ii. Commodity-linked bear bond: Unlike traditional debt securities that pay a scheduled rate of coupon interest on a periodic basis and the par amount of principal at maturity, the commodity-linked bear bond allows an investor to participate in a decline in a commodity’s price. In exchange for a lower than market coupon, buyers of a bear tranche receive a redemption value that exceeds the purchase price if the commodity price has declined by the maturity date. 20-11
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16. a. Position S T < 80 80 S T 85 S T > 85 Write call, X = $85 0 0 –(S T – 85) Write put, X = $80 –(80 – S T ) 0 0 Total S T – 80 0 85 – S T S T 80 85 Payoff Write call Write put b. Proceeds from writing options: Call: $0.95 Put: $0.55 Total: $1.50 If IBM sells at $83 on the option maturity date, both options expire out of the money, and profit = $1.50. If IBM sells at $90 on the option maturity date, the call written results in a cash outflow of $5 at maturity, and an overall profit of: $1.50 – $5 = $3.50 c. You break even when either the put or the call results in a cash outflow of $1.50. For the put, this requires that: $1.50 = $80.00 – S T S T = $78.50 For the call, this requires that: $1.50 = S T – $90 S T = $91.50 d. The investor is betting that IBM stock price will have low volatility. This position is similar to a straddle.
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