Question
22. You currently have 2000 shares of Daimler-Benz common stock which currently priced at $75 a share. You agree to buy a house in Spain
22. You currently have 2000 shares of Daimler-Benz common stock which currently priced at $75 a share. You agree to buy a house in Spain priced at $160,000 payable in 3 months from now. You are concerned that the stock price of Daimler-Benz could drop significantly so that the proceeds from the sale of the stock would be insufficient to cover the payment for the house. You are looking for the strategy to protect the $ 75 a share or to enhance the value of the portfolio to $160,000. You borrow (to pay the premium) and lend (invest the premium) at the risk free rate of 10% par annum. Four strategies were proposed:
a) Purchase a 3-month at the money put contracts on Daimler-Benz stock, and finance the purchase by selling 3-month calls with an exercise price of $80.
b) Write a 3-month call option on Daimler-Benz stock at a strike price of $80 with an option premium of $2.
c) Purchase a 3-month at the money put option on Daimler-Benz with an option premium of $2.
d) Sell the stock at $75 a share and invest the proceeds in a 10% 3-month T-bill.
Question: Rank all four strategies in terms of the objective stated above and indicate the best one. Support your conclusion by showing the payoff structure of each strategy under four possible states: minimum payoff, stock price = $75, stock price= $80 and maximum payoff
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