In: Finance

Suppose the stock price is $40 and the effective annual interest rate is 8%.

a. Draw on a single graph payoff and profit diagrams for the following options:

(i) 35-strike call with a premium of $9.12.

(ii) 40-strike call with a premium of $6.22.

(iii) 45-strike call with a premium of $4.08.

b. Consider your payoff diagram with all three options graphed together. Intuitively, why should the option premium decrease with the strike price?

Given that the EAR = 8%

- 35-strike call with a premium of $9.12
- \( \begin{align*} \text{purchased call payoff} &= \max(0, \text{spot price at expiration} - \text{strike price})\\ &= \max(0, S - 35)\\ &= \begin{cases} 0 & S<35 \\ S-35 & S\geq 35 \end{cases} \\ \text{purchased call profit} &= \max(0, \text{spot price at expiration} - \text{strike price}) - \text{future value of option premium} \\ &= \max(0, S-35) - 9.12(1.08) \\ &= \max(-9.8496, S-35-9.8496)\\ &= \max(-9.8496, S-44.8496)\\ &= \begin{cases} -9.8496 & S<35 \\ S-44.8496 & S\geq 35 \end{cases} \end{align*} \)

- 40-strike call with a premium of $6.22
- \( \begin{align*} \text{purchased call payoff} &= \max(0, \text{spot price at expiration} - \text{strike price})\\ &= \max(0, S - 40)\\ &= \begin{cases} 0 & S<40 \\ S-40 & S\geq 40 \end{cases} \\ \text{purchased call profit} &= \max(0, \text{spot price at expiration} - \text{strike price}) - \text{future value of option premium} \\ &= \max(0, S-40) - 6.22(1.08) \\ &= \max(-6.7176, S-40-6.7176)\\ &= \max(-6.7176, S-46.7176)\\ &= \begin{cases} -6.7176 & S<40 \\ S-46.7176 & S\geq 40 \end{cases} \end{align*} \)

- 45-strike call with a premium of $4.08
- \( \begin{align*} \text{purchased call payoff} &= \max(0, \text{spot price at expiration} - \text{strike price})\\ &= \max(0, S - 45)\\ &= \begin{cases} 0 & S<45 \\ S-45 & S\geq 45 \end{cases} \\ \text{purchased call profit} &= \max(0, \text{spot price at expiration} - \text{strike price}) - \text{future value of option premium} \\ &= \max(0, S-45) - 4.08(1.08) \\ &= \max(-4.4064, S-45-4.4064)\\ &= \max(-4.4064, S-49.4064)\\ &= \begin{cases} -4.4064 & S<45 \\ S-49.4064 & S\geq 45 \end{cases} \end{align*} \)

- Option premium decreases with the strike price because: the payoff of a long call is \( \max(0,S-K) \). As \( K \) increases, the payoff gets worse and the option becomes less valuable. Ceteris paribus, the higher strike price, the lower the premium.

The option premium decrease with the strike price because if the payoff of a long call is \( \max(0, S-K) \) then as \( K \) increases, the becomes less valuable.

Zero growth: Ron Santana is interested in buying the stock of First National Bank. While the bank's management expects no growth in the near future, Ron is attracted by the dividend income. Last year the bank paid a dividend of $5.65. If Ron requires a return of 14 percent on such stocks, what is the maximum price he should be willing to pay for a share of the bank's stock?

What is the price of a T-Bill 98 days prior to maturity if the face amount is 100 and the yield (the simple interest rate) is 2.7% per annum.

Rooney Manufacturing Co. expects to make 31,700 chairs during the year 1 accounting period. The company made 3,600 chairs in January. Materials and labor costs for January were $16,700 and $25,200, respectively. Rooney produced 2,000 chairs in February. Material and labor costs for February were $8,900 and $13,400, respectively. The company paid the $729,100 annual rental fee on its manufacturing facility on January 1, year 1. The rental fee is allocated based on the total estimated number of units to...

Must be in paragrpah form, elaborate well and don't copy paste.

It's a marketing question that would help students gain answers

It's a marketing question that would help students gain answers

Determine whether the distribution is a discrete probability distribution. If not, state why.
x
P(x)
0
0.1
1
0.5
2
0.05
3
0.25
4
0.1

Why does a shift in perceived demand cause a shift in marginal revenue for monopolistic competitive firms?

Which of the following statements regarding the impact of an increase in dividends on the share price of a firm is MOST true?
A. The share price of the firm is likely to go down on the announcement date due to the signaling effect and go up by the amount of the dividend on the ex-dividend date.
B. The share price of the firm is likely to go up on the announcement date due to the signaling effect and go...

Consider a 5% 1 year to maturity coupon bond with a face value of $100. If the price of the bond is $90, what is the yield to maturity?

Latest Questions

- In alphabetical order, the six most common last names in the United States in 2018
- moment of inertia of a rod
- Prepare a post closing trial balance
- During the nineteenth century, one way political bosses gained voter support was by
- income statement and retained earnings statement
- Computing profit Margin, Turnovers, and Return on investments
- Return on Investments and Residual income