bkmsol_ch20

# The best strategy in this case would be c since it

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The best strategy in this case would be (c) since it satisfies the two requirements of preserving the \$350,000 in principal while offering a chance of getting \$450,000. Strategy (a) should be ruled out since it leaves Jones exposed to the risk of substantial loss of principal. Our ranking would be: (1) strategy c; (2) strategy b; (3) strategy a. 20-5

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9. a. Position S T 780 S T > 780 Buy stock S T S T Buy put 780 – S T 0 Total 780 S T Position S T 840 S T > 840 Buy call 0 S T – 840 Buy T-bills 840 840 Total 840 S T Payoff S T 840 780 780 840 Bills plus calls Protective put strategy b. The bills plus call strategy has a greater payoff for some values of S T and never a lower payoff. Since its payoffs are always at least as attractive and sometimes greater, it must be more costly to purchase. 20-6
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.
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The best strategy in this case would be c since it...

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