Chapter 5: Q4CP (page 517)
Suresh Singh, CFA, is analyzing a convertible bond. The characteristics of the bond and the underlying common stock are given in the following exhibit:
Compute the bond’s:
a. Conversion value.
b. Market conversion price.
Answer
a. $880
b. $47.73
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What type of interest rate swap would be appropriate for a speculator who believes interest rates soon will fall?
A call option on Jupiter Motors stock with an exercise price of \(75 and one-year expiration is selling at \)3. A put option on Jupiter stock with an exercise price of \(75 and one-year expiration is selling at \)2.50. If the risk-free rate is 8% and Jupiter pays no dividends, what should the stock price be?
Return to Problem 35. Value the call option using the risk-neutral shortcut described in the box on page 533. Confirm that your answer matches the value you get using the two-state approach.
Question: You are attempting to value a call option with an exercise price of \(100 and one year to expiration. The underlying stock pays no dividends, its current price is \)100, and you believe it has a 50% chance of increasing to \(120 and a 50% chance of decreasing to \)80.
The risk-free rate of interest is 10%. Calculate the call option’s value using the two-state stock price model.
The current level of the S&P 500 is 1,200. The dividend yield on the S&P 500 is 2%. The risk-free interest rate is 1%. What should a futures contract with a one-year maturity be selling for?
The common stock of the P.U.T.T. Corporation has been trading in a narrow price range for the past month, and you are convinced it is going to break far out of that range in the next three months. You do not know whether it will go up or down, however. The current price of the stock is \(100 per share, the price of a three-month call option with an exercise price of \)100 is \(10, and a put with the same expiration date and exercise price costs \)7.
a. What would be a simple options strategy to exploit your conviction about the stock price’s future movements?
b. How far would the price have to move in either direction for you to make a profit on your initial investment?
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