20 6 c the initial cost of the stock plus put

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c. The initial cost of the stock plus put position is: $900 + $6 = $906 The initial cost of the bills plus call position is: $810 + $120 = $930 S T = 700 S T = 840 S T = 900 S T = 960 Stock 700 840 900 960 + Put 80 0 0 0 Payoff 780 840 900 960 Profit –126 –66 –6 54 Bill 840 840 840 840 + Call 0 0 60 120 Payoff 840 840 900 960 Profit –90 –90 –30 +30 Profit Bills plus calls Protective put -90 -126 780 840 S T d. The stock and put strategy is riskier. This strategy performs worse when the market is down and better when the market is up. Therefore, its beta is higher. e. Parity is not violated because these options have different exercise prices. Parity applies only to puts and calls with the same exercise price and expiration date. 10. a. Donie should choose the long strangle strategy. A long strangle option strategy consists of buying a put and a call with the same expiration date and the same underlying asset, but different exercise prices. In a strangle strategy, the call has an exercise price above the stock price and the put has an exercise price below the stock price. An investor who buys (goes long) a strangle expects that the price of the underlying asset (TRT Materials in this case) will either move substantially below the exercise price on the put or above the exercise price on the call. With respect to TRT, the long strangle investor buys both the put option and the call option for a total cost of $9.00, and will experience a profit if the stock price moves more than $9.00 above the call exercise price or more than $9.00 below the put exercise price. This strategy would enable Donie's client to profit from a large move in the stock price, either up or down, in reaction to the expected court decision. 20-7
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b. i. The maximum possible loss per share is $9.00, which is the total cost of the two options ($5.00 + $4.00). ii. The maximum possible gain is unlimited if the stock price moves outside the breakeven range of prices. iii. The breakeven prices are $46.00 and $69.00. The put will just cover costs if the stock price finishes $9.00 below the put exercise price (i.e., $55 $9 = $46), and the call will just cover costs if the stock price finishes $9.00 above the call exercise price (i.e., $60 + $9 = $69). 11. a. & b. The Excel spreadsheet for both parts (a) and (b) is shown on the next page, and the profit diagrams are on the following page. 12. The farmer has the option to sell the crop to the government for a guaranteed minimum price if the market price is too low. If the support price is denoted P S and the market price P m then the farmer has a put option to sell the crop (the asset) at an exercise price of P S even if the price of the underlying asset (P m ) is less than P S . 13. The bondholders have, in effect, made a loan which requires repayment of B dollars, where B is the face value of bonds. If, however, the value of the firm (V) is less than B, the loan is satisfied by the bondholders taking over the firm. In this way, the bondholders are forced to “pay” B (in the sense that the loan is cancelled) in return for an asset worth only V. It is as though the bondholders wrote a put on an asset worth V with exercise price B.
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