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. 13. 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. 14. 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 . 15. 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. 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. 16. The manager receives a bonus if the stock price exceeds a certain value and receives nothing otherwise. This is the same as the payoff to a call option. 20-7
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Chapter 20 - Options Markets: Introduction Spreadsheet for Problem 13: 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 20-8
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Chapter 20 - Options Markets: Introduction 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 Profit diagram for problem 13: 20-9 Spreads and Straddles -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
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Chapter 20 - Options Markets: Introduction 17. a. Position S T < 100 100 S T 105 S T > 105 Write call, X = $105 0 0 –(S T – 105) Write put, X = $100 –(100 – S T ) 0 0 Total S T – 100 0 105 – S T S T 100 105 Payoff Write call Write put b. Proceeds from writing options: Call: $4.40 Put: $2.53 Total: $6.93 If IBM sells at $103 on the option expiration date, both options expire out of the money, and profit = $6.93. If IBM sells at $110 on the option expiration date, the
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  • Fall '10
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  • Options, Strike price

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