Chapter 5: Q6B (page 512)
An investor buys a call at a price of \(4.50 with an exercise price of \)40. At what stock price will the investor break even on the purchase of the call?
$44.50
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A corporation plans to issue $10 million of 10-year bonds in three months. At current yields the bonds would have modified duration of eight years. The T-note futures contract is selling at F0 = 100 and has modified duration of six years. How can the firm use this futures contract to hedge the risk surrounding the yield at which it will be able to sell its bonds? Both the bond and the contract are at par value.
Reconsider the determination of the hedge ratio in the two-state model (Section 16.2), where we showed that one-third share of stock would hedge one option. What would be the hedge ratio for each of the following exercise prices: \(120, \)110, \(100, \)90? What do you conclude about the hedge ratio as the option becomes progressively more in the money?
Consider a stock that will pay a dividend of D dollars in one year, which is when a futures contract matures.
Consider the following strategy: Buy the stock, short a futures contract on the stock, and borrow dollars, where is the current price of the stock.
a. What are the cash flows now and in one year? (Hint: Remember the dividend the stock will pay.)
b. Show that the equilibrium futures price must beto avoid arbitrage.
c. Call the dividend yield d = D / , and conclude that .
What is the difference in cash flow between short-selling an asset and entering a short futures position?
Use the following case in answering Problems 10 – 15 : Mark Washington, CFA, is an analyst with BIC. One year ago, BIC analysts predicted that the U.S. equity market would most likely experience a slight downturn and suggested delta-hedging the BIC portfolio.
As predicted, the U.S. equity markets did indeed experience a downturn of approximately 4% over a 12-month period. However, portfolio performance for BIC was disappointing, lagging its peer group by nearly 10%. Washington has been told to review the options strategy to determine why the hedged portfolio did not perform as expected.
Washington considers a put option that has a delta of .65. If the price of the underlying asset decreases by $6, then what is the best estimate of the change in option price?
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