Question
1) You are interested in Speculative Holdings which is currently trading at a market price of $4.2 per share. You expect it to achieve earnings
1) You are interested in Speculative Holdings which is currently trading at a market price of $4.2 per share. You expect it to achieve earnings next year of $3,420,000 and project a dividend next year of $0.137 per share. The firm has 10 million shares in issue and you estimate that you would require a return of 12% on this investment. What position would you take on Speculative Holdings? (7 marks)
2) You are told by your investment advisor that Laduma Co. is expected to earn $5 per share next year, $6 per share the following year and that thereafter earnings are expected to grow by 8 percent per year. The dividend payout ratio is 60 percent and the required rate of return on Laduma shares is 15 percent. If the current share price is $40, would you expect your adviser to make a buy, hold or sell recommendation? If transaction costs are $2,50 per share, would you follow his advice? (10 marks)
3)Your firm is one of the largest bakery's in the area. As part of your risk management process, you are considering using options to hedge the price risk on your biggest input - wheat. You have determined that a price of $52/per ton would allow for you to keep the same profit margin as last year. The following wheat options offer a strike price of $50/per ton expiring in 1 month:
- Call options on wheat are selling at a premium of $0.87 per ton.
- Put options on wheat are selling for $0.72 per ton.
a)Given the information above, will you need a call or a put option? [1 mark]
b)If each option is for 100 tons, and you require 1000 tons of wheat, demonstrate the outcome if, at expiry, the spot price of wheat is (i) $40 per ton and (ii) $60 per ton. [12 marks].
4)Lumo is a trader at ZNF Equity traders and has just identified a stock, UFSI Limited, which is currently trading at $25 per share. Lumo decides to take a long position in at-the money put option and simultaneously buys one share of UFSI stock. The put option expires in 3 months' time and costs $2.5 per share. Assume a contract consists of one put option.
Required:
a)Identify the strategy employed by Lumo above. (2)
b)Tabulate the Profit to the strategy at expiration for the following(8)
i)Exercise price $30; Stock price 20.
ii)Exercise price $30; Stock price 35.
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