Question
1. Assume that CAPM holds. Suppose that the expected return of the market portfolio is 7% in 2022 and the standard deviation of market return
1. Assume that CAPM holds. Suppose that the expected return of the market portfolio is 7% in 2022 and the standard deviation of market return in 2022 is 12%. Assume that the covariance of Walmart's stock return with the market is 0.00144, and the covariance of Alphabet's stock return with the market is 0.01512. The standard deviations of Walmart and Alphabet stock return are 6% and 20%, respectively. What proportion of Alphabets and Walmarts risk (variance) can be diversified away according to CAPM?
2. Firm XYZ's stock is currently trading at $125. The put option on XYZ's stock with a strike price of $110 and an expiration date one year from today costs $6. The call option on XYZ's stock with a strike price of $135 and an expiration date one year from today costs $8.
A. If you spent $8000 to purchase 1000 of the call options mentioned above. What is your rate of return if XYZ's stock price raises to $140 one year later?
B. If you purchased a share of stock and purchased a put option mention above. Calculate the payoff, profit, and rate of return of this investment when XYZ's share price is $100 and $135, respectively one year later.
C. If you purchased a share of stock and sold a call option mention above. Calculate the payoff, profit, and rate of return of this investment when XYZ's share price is $125 and $140, respectively one year later.
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