This strategy would enable donies client to profit

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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. 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). 2. 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. 20-17
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Chapter 20 - Options Markets: Introduction 3. i. Conversion value of a convertible bond is the value of the security if it is converted immediately. That is: Conversion value = market price of the common stock × conversion ratio = $40 × 22 = $880 ii. Market conversion price is the price that an investor effectively pays for the common stock if the convertible bond is purchased: Market conversion price = market price of the convertible bond/conversion ratio = $1,050/22 = $47.73 4. a.i. The current market conversion price is computed as follows: Market conversion price = market price of the convertible bond/conversion ratio = $980/25 = $39.20 ii. The expected one-year return for the Ytel convertible bond is: Expected return = [(end of year price + coupon)/current price] – 1 = [($1,125 + $40)/$980] – 1 = 0.1888 = 18.88% iii. The expected one-year return for the Ytel common equity is: Expected return = [(end of year price + dividend)/current price] – 1 = ($45/$35) – 1 = 0.2857 = 28.57% b. The two components of a convertible bond’s value are: the straight bond value, which is the convertible bond’s value as a bond, and; the option value, which is the value associated with the potential conversion into equity. (i.) In response to the increase in Ytel’s common equity price, the straight bond value should stay the same and the option value should increase.
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