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essentials of investments

Questions and Answers of Essentials of Investments

3. Suresh Singh, CFA, is analyzing a convertible bond. The characteristics of the bond and the underlying common stock are given in the following exhibit:Convertible Bond Characteristics Par value
2. Martin Bowman is preparing a report distinguishing traditional debt securities from structured note securities. Discuss how the following structured note securities differ from a traditional debt
1. Donna Donie, CFA, has a client who believes the common stock price of TRT Materials (currently$58 per share) could move substantially in either direction in reaction to an expected court decision
27. Demonstrate that an at-the-money call option on a given stock must cost more than an at-the-money put option on that stock with the same maturity. The stock will pay no dividends until after the
26. Using the IBM option prices in Figure 20.1 , calculate the market price of a riskless zero-coupon bond with face value $105 that matures in February on the same date as the listed options.
25. You are attempting to formulate an investment strategy. On the one hand, you think there is great upward potential in the stock market and would like to participate in the upward move if it
23. You write a call option with X = 50 and buy a call with X = 60. The options are on the same stock and have the same expiration date. One of the calls sells for $3; the other sells for $9.a. Draw
22. Joe Finance has just purchased a stock index fund, currently selling at $400 per share. To protect against losses, Joe also purchased an at-the-money European put option on the fund for $20, with
21. You write a put option with X = 100 and buy a put with X = 110. The puts are on the same stock and have the same expiration date.a. Draw the payoff graph for this strategy.b. Draw the profit
20. You buy a share of stock, write a 1-year call option with X = $10, and buy a 1-year put option with X = $10. Your net outlay to establish the entire portfolio is $9.50. What is the risk-free
19. A Ford put option with strike price 60 trading on the Acme options exchange sells for $2. To your amazement, a Ford put with the same maturity selling on the Apex options exchange but with strike
18. Consider the following portfolio. You write a put option with exercise price 90 and buy a put option on the same stock with the same expiration date with exercise price 95.a. Plot the value of
17. Consider the following options portfolio. You write a February expiration call option on IBM with exercise price 105. You write a February IBM put option with exercise price 100.a. Graph the
16. An executive compensation scheme might provide a manager a bonus of $1,000 for every dollar by which the company’s stock price exceeds some cutoff level. In what way is this arrangement
15. In what ways is owning a corporate bond similar to writing a put option? A call option?
14. The agricultural price support system guarantees farmers a minimum price for their output.Describe the program provisions as an option. What is the asset? The exercise price?
13. Use the spreadsheet from the Excel Application boxes on spreads and straddles (available at www.mhhe.com/bkm; link to Chapter 20 material) to answer these questions.a. Plot the payoff and profit
12. Joseph Jones, a manager at Computer Science, Inc. (CSI), received 10,000 shares of company stock as part of his compensation package. The stock currently sells at $40 a share. Joseph would like
11. A bearish spread is the purchase of a call with exercise price X 2 and the sale of a call with exercise price X 1 , with X 2 greater than X 1 . Graph the payoff to this strategy and compare it to
10.a. A butterfly spread is the purchase of one call at exercise price X 1 , the sale of two calls at exercise price X 2 , and the purchase of one call at exercise price X 3 . X 1 is less than X 2 ,
9. In this problem, we derive the put-call parity relationship for European options on stocks that pay dividends before option expiration. For simplicity, assume that the stock makes one dividend
8. The common stock of the C.A.L.L. Corporation has been trading in a narrow range around $50 per share for months, and you believe it is going to stay in that range for the next 3 months. The price
7. 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 3 months.You
5. Turn back to Figure 20.1 , which lists prices of various IBM options. Use the data in the figure to calculate the payoff and the profits for investments in each of the following February maturity
4. Why do you think the most actively traded options tend to be the ones that are near the money?
3. What are the trade-offs facing an investor who is considering writing a call option on an existing portfolio?
2. What are the trade-offs facing an investor who is considering buying a put option on an existing portfolio?
1. We said that options can be used either to scale up or reduce overall portfolio risk. What are some examples of risk-increasing and risk-reducing options strategies? Explain each.
Here are data on three hedge funds. Each fund charges its investors an incentive fee of 20% of total returns. Suppose initially that a fund of funds (FF) manager buys equal amounts of each of these
Return again to Problem 14.Now suppose that the manager misestimates the beta of Waterworks stock, believing it to be .50 instead of .75. The standard deviation of the monthly market rate of return
Return to Problem 14.a. Suppose you hold an equally weighted portfolio of 100 stocks with the same alpha, beta, and residual standard deviation as Waterworks. Assume the residual returns (the e terms
Suppose a hedge fund follows the following strategy. Each month it holds $100 million of an S&P 500 index fund and writes out-of-the-money put options on $100 million of the index with exercise price
Log in to Connect and link to Chapter 26 to find a spreadsheet containing monthly values of the S&P 500 index. Suppose that in each month you had written an out-of-the-money put option on one unit of
Reconsider the hedge fund in Problem 10.Suppose it is January 1, the standard deviation of the fund’s annual returns is 50%, and the risk-free rate is 4%. The fund has an incentive fee of 20%, but
A hedge fund with $1 billion of assets charges a management fee of 2% and an incentive fee of 20% of returns over a money market rate, which currently is 5%. Calculate total fees, both in dollars and
With respect to hedge fund investing, the net return to an investor in a fund of funds would be lower than that earned from an individual hedge fund because of:a. Both the extra layer of fees and the
If the current exchange rate is $1.35/£, the 1-year forward exchange rate is $1.45/£, and the interest rate on British government bills is 3% per year, what risk-free dollar-denominated return can
Calculate the contribution to total performance from currency, country, and stock selection for the manager in the example below. All exchange rates are expressed as units of foreign currency that
Suppose a U.S. investor wishes to invest in a British firm currently selling for £40 per share. The investor has $10,000 to invest, and the current exchange rate is $2/£.a. How many shares can the
In Figure 25.2, we provide stock market returns in both local and dollar-denominated terms.Which of these is more relevant? What does this have to do with whether the foreign exchange risk of an
Go to Kenneth French’s data library site at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. Select two industry portfolios of your choice and download 36 months of data.
Kelli Blakely is a portfolio manager for the Miranda Fund, a core large-cap equity fund.The market proxy and benchmark for performance measurement purposes is the S&P 500.Although the Miranda
Bill Smith is evaluating the performance of four large-cap equity portfolios: Funds A, B, C, and D. As part of his analysis, Smith computed the Sharpe ratio and the Treynor measure for all four
A global equity manager is assigned to select stocks from a universe of large stocks throughout the world. The manager will be evaluated by comparing her returns to the return on the MSCI World
Consider the following information regarding the performance of a money manager in a recent month. The table represents the actual return of each sector of the manager’s portfolio in column 1, the
Consider the two (excess return) index-model regression results for stocks A and B. The risk-free rate over the period was 6%, and the market’s average return was 14%. Performance is measured using
A manager buys three shares of stock today and then sells one of those shares each year for the next three years. His actions and the price history of the stock are summarized below. The stock pays
XYZ’s stock price and dividend history are as follows:Year Beginning-of-Year Price Dividend Paid at Year-End 2016 $100 $4 2017 120 4 2018 90 4 2019 100 4 An investor buys three shares of XYZ at the
Consider the rate of return of stocks ABC and XYZ.Year rABC rXYZ 1 20% 30%2 12 12 3 14 18 4 3 0 5 1 −10a. Calculate the arithmetic average return on these stocks over the sample period.b. Which
A household savings-account spreadsheet shows the following entries:Date Additions Withdrawals Value 1/1/2016 148,000 1/3/2016 2,500 3/20/2016 4,000 7/5/2016 1,500 12/2/2016 13,460 3/10/2017 23,000
Consider these futures market data for the June delivery S&P 500 contract, exactly one year from today. The S&P 500 index is at 1,950, and the June maturity contract is at F0 = 1,951.a. If the
Firm ABC enters a 5-year swap with firm XYZ to pay LIBOR in return for a fixed 6% rate on notional principal of $10 million. Two years from now, the market rate on 3-year swaps is LIBOR for 5%; at
Suppose the U.S. yield curve is flat at 4% and the euro yield curve is flat at 3%. The current exchange rate is $1.20 per euro. What will be the swap rate on an agreement to exchange currency over a
Suppose that the price of corn is risky, with a beta of .5. The monthly storage cost is $.03 per bushel, and the current spot price is $5.50, with an expected spot price in three months of $5.88.If
If the corn harvest today is poor, would you expect this fact to have any effect on today’s futures prices for corn to be delivered (post-harvest) two years from today? Under what circumstances
a. If the spot price of gold is $1,500 per troy ounce, the risk-free interest rate is 2%, and storage and insurance costs are zero, what should be the forward price of gold for delivery in one year?
A corporation plans to issue $10 million of 10-year bonds in three months. At current yields the bonds would have modified duration of 8 years. The T-note futures contract is selling at F0 =100 and
Yields on short-term bonds tend to be more volatile than yields on long-term bonds. Suppose that you have estimated that the yield on 20-year bonds changes by 10 basis points for every 15-basis-point
Return to Figure 23.7. Suppose the LIBOR rate when the first listed Eurodollar contract matures in September is .60%. What will be the profit or loss to each side of the Eurodollar contract?
Suppose that the relationship between the rate of return on IBM stock, the market index, and a computer industry index can be described by the following regression equation: rIBM =.5rM +
You manage a $19.5 million portfolio, currently all invested in equities, and believe that the market is on the verge of a big but short-lived downturn. You would move your portfolio temporarily into
Consider the futures contract written on the S&P 500 index and maturing in one year. The interest rate is 3%, and the future value of dividends expected to be paid over the next year is $35.The
Both gold-mining firms and oil-producing firms might choose to use futures to hedge uncertainty in future revenues due to price fluctuations. But trading activity sharply tails off for maturities
A U.S. exporting firm may use foreign exchange futures to hedge its exposure to exchange rate risk. Its position in futures will depend in part on anticipated payments from its customers denominated
a. How should the parity condition (Equation 22.2) for stocks be modified for futures contracts on Treasury bonds? What should play the role of the dividend yield in that equation?b. In an
The Excel Application box in the chapter (available in Connect; link to Chapter 22 material)shows how to use the spot-futures parity relationship to find a “term structure of futures prices,”that
The S&P portfolio pays a dividend yield of 1% annually. Its current value is 2,000. The T-bill rate is 4%. Suppose the S&P futures price for delivery in 1 year is 2,050. Construct an arbitrage
The multiplier for a futures contract on a stock market index is $50. The maturity of the contract is 1 year, the current level of the index is 1,800, and the risk-free interest rate is .5% per
Consider a stock that pays no dividends on which a futures contract, a call option, and a put option trade. The maturity date for all three contracts is T, the exercise price of both the put and the
Suppose the value of the S&P 500 stock index is currently 2,000.a. If the 1-year T-bill rate is 3% and the expected dividend yield on the S&P 500 is 2%, what should the 1-year maturity futures price
Determine how a portfolio manager might use financial futures to hedge risk in each of the following circumstances:a. You own a large position in a relatively illiquid bond that you want to sell.b.
a. Turn to the Mini-S&P 500 contract in Figure 22.1. If the margin requirement is 10% of the futures price times the contract multiplier of $50, how much must you deposit with your broker to trade
Return to Problem 38.a. What will be the payoff to the put, Pu, if the stock goes up?b. What will be the payoff, Pd, if the stock price falls?c. Value the put option using the risk-neutral shortcut
Return to Problem 36.Value the call option using the risk-neutral shortcut described in the box in Section 21.3. Confirm that your answer matches the value you get using the two-state approach.
Use the put-call parity relationship to demonstrate that an at-the-money call option on a nondividend-paying stock must cost more than an at-the-money put option. Show that the prices of the put and
Suppose you are attempting to value a 1-year expiration option on a stock with volatility(i.e., annualized standard deviation) of σ = .40. What would be the appropriate values for u and d if your
Suppose that JPMorgan Chase sells call options on $1.25 million worth of a stock portfolio with beta = 1.5. The option delta is .8. It wishes to hedge its resultant exposure to a market advance by
Using the data in Problem 46, suppose that 3-month put options with a strike price of $90 are selling at an implied volatility of 34%. Construct a delta-neutral portfolio comprising positions in
Suppose that call options on ExxonMobil stock with time to expiration 3 months and strike price $90 are selling at an implied volatility of 30%. ExxonMobil stock currently is $90 per share, and the
Goldman Sachs believes that market volatility will be 20% annually for the next three years.Three-year at-the-money call and put options on the market index sell at an implied volatility of 22%. What
“The beta of a call option on the S&P 500 index with an exercise price of 1,930 is greater than the beta of a call on the index with an exercise price of 1,940.” True or false?
XYZ Corp. will pay a $2 per share dividend in two months. Its stock price currently is $60 per share. A call option on XYZ has an exercise price of $55 and 3-month time to expiration.The risk-free
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%
Let p(S, T, X) denote the value of a European put on a stock selling at S dollars, with time to maturity T, and with exercise price X, and let P(S, T, X) be the value of an American put.a. Evaluate
Return to Example 21.1. Use the binomial model to value a 1-year European put option with exercise price $110 on the stock in that example. Confirm that your solution for the put price satisfies
You would like to be holding a protective put position on the stock of XYZ Co. to lock in a guaranteed minimum value of $100 at year-end. XYZ currently sells for $100. Over the next year the stock
You are very bullish (optimistic) on stock EFG, much more so than the rest of the market.In each question, choose the portfolio strategy that will give you the biggest dollar profit if your bullish
These three put options are all written on the same stock. One has a delta of −.9, one a delta of−.5, and one a delta of −.1. Assign deltas to the three puts by filling in this table.Put X
A collar is established by buying a share of stock for $50, buying a 6-month put option with exercise price $45, and writing a 6-month call option with exercise price $55. On the basis of the
Consider a 6-month expiration European call option with exercise price $105. The underlying stock sells for $100 a share and pays no dividends. The risk-free rate is 5%. What is the implied
If the time to expiration falls and the put price rises, then what has happened to the put option’s implied volatility?
Which of the following statements regarding the goal of a delta-neutral portfolio is most accurate? One example of a delta-neutral portfolio is to combine a:a. Long position in a stock with a short
Return to Problem 19.Will the number of call options written for a delta-neutral hedge increase or decrease if the stock price falls?
BIC owns 51,750 shares of Smith & Oates. The shares are currently priced at $69. A call option on Smith & Oates with a strike price of $70 is selling at $3.50 and has a delta of .69. What is the
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?
After discussing the concept of a delta-neutral portfolio, Washington determines that he needs to further explain the concept of delta. Washington draws the value of an option as a function of the
Which of the following best explains a delta-neutral portfolio? A delta-neutral portfolio is perfectly hedged against:a. Small price changes in the underlying asset.b. Small price decreases in the
What would be the Excel formula in Spreadsheet 21.1 for the Black-Scholes value of a straddle position?
Recalculate the value of the call option in Problem 11, successively substituting one of the changes below while keeping the other parameters as in Problem 11:a. Time to expiration = 3 months.b.
Find the Black-Scholes value of a put option on the stock in Problem 11 with the same exercise price and expiration as the call option.

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