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ADCAP International is a U.S.-based company which sells its products primarily in overseas markets. The company's stock

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ADCAP International is a U.S.-based company which sells its products primarily in overseas markets. The company's stock is currently trading at $50 per share. Depending on the outcome of U.S. trade negotiations with the countries to which ADCAP exports its products, the company's stock price is expected to be either $65 or $30 in six months. The risk free rate is 8 percent per year. What is the value of a put option on ADCAP stock that has an exercise price of $40 per share?

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Here we solve directly for the value of the put option First we determine the payoffs for the stock ...View the full answer


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Fundamentals of Corporate Finance

Fundamentals of Corporate Finance

ISBN: 978-1118845899

3rd edition

Authors: Robert Parrino, David S. Kidwell, Thomas W. Bates

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A put option is a financial contract that gives the owner the right, but not the obligation, to sell an underlying asset, such as a stock or a commodity, at a predetermined price, known as the strike price, on or before a specific date, known as the expiration date. Put options are used by investors as a form of insurance against a decline in the value of the underlying asset. If an investor expects the value of an asset to fall in the future, they can purchase a put option on that asset. If the value of the asset does fall, the put option will increase in value, allowing the investor to sell the asset at the higher strike price. For example, if an investor owns 100 shares of a stock that is currently trading at $50 per share, they may purchase a put option with a strike price of $45 and an expiration date three months in the future. If the stock price falls to $40 before the expiration date, the investor can exercise the put option and sell their shares for $45 each, even though the market price is only $40. This would allow the investor to limit their losses. It\'s important to note that purchasing a put option involves paying a premium to the seller of the option, and the investor can lose the entire premium if the price of the underlying asset does not decline as expected. Put options are just one type of financial derivative and should only be used by experienced investors who understand the risks involved.

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