4.1 Assume that you have 120 shares of XYZ stock which has a volatility of 30% and a current stock price of 80 per share. XYZ pays no dividends The risk-free interest rate is 3%. Use the Black-Scholes option pricing model to value a three-month, at-the-money European put option on XYZ stock. What action should you take to hedge using put options? What would be the total value of this transaction? (12%) 4.2 In mid-September, there are two outstanding call option contracts available on the stock of ABC: Call # | Exercise Price (E) | Expiration Date | Market Price ( 60 70 December 19 December 19 7.90 3.09 2 Assume that you form a portfolio consisting of one Call #1 held long and two Calls #2 held short, complete the following table showing your intermediate steps Price of ABC Stock at Initial Cost Payoff on Call Payoff on Call (Net) Profit on Total Position #1 Position #2 Position ration ( 50 60 65 70 75 80 85 Draw the (net) profit diagram on expiry of your portfolio. What is (are) the breakeven stock price(S)? What is the point of maximum profit? Under what market conditions will this strategy generally make sense? (15%) 4.1 Assume that you have 120 shares of XYZ stock which has a volatility of 30% and a current stock price of 80 per share. XYZ pays no dividends The risk-free interest rate is 3%. Use the Black-Scholes option pricing model to value a three-month, at-the-money European put option on XYZ stock. What action should you take to hedge using put options? What would be the total value of this transaction? (12%) 4.2 In mid-September, there are two outstanding call option contracts available on the stock of ABC: Call # | Exercise Price (E) | Expiration Date | Market Price ( 60 70 December 19 December 19 7.90 3.09 2 Assume that you form a portfolio consisting of one Call #1 held long and two Calls #2 held short, complete the following table showing your intermediate steps Price of ABC Stock at Initial Cost Payoff on Call Payoff on Call (Net) Profit on Total Position #1 Position #2 Position ration ( 50 60 65 70 75 80 85 Draw the (net) profit diagram on expiry of your portfolio. What is (are) the breakeven stock price(S)? What is the point of maximum profit? Under what market conditions will this strategy generally make sense? (15%)