Question
Back in 2013 You are interested in investing in Bank of America (BAC). a. When in November 2013 did BAC first close above $14 and
Back in2013You are interested in investing in Bank of America (BAC).
a. When in November 2013 did BAC first close above $14 and begin to appreciate? (look athistoryof stock prices) What is the closing price on 11/29? Assuming that BAC did not pay a dividend (this is close to true given that the quarterly dividend is currently equal to 0.04), what was the return on BAC stock over this time period (buy at 14 in early November to sell today in December 5, 2013)?
You believe that the BAC stock is undervalued and that it will increase substantially over the next several weeks. You consider different ways to profit from an increase. On Wednesday 11/29 acall optioncurrent (look at history too) with January expiration and strike price of 16.00 is currently trading at C=0.47.
b. Is the option currently in-the-money or out-of-the-money? What is intrinsic value of the option? What is its time value? NOTE the price changes from 2013 to 2017!
You decide to invest $20,000 and are considering three alternatives:
(1)All stocks:Invest all of your money in BAC stock.
(2)All options:Invest all of your money in BAC options.
(3)Options and risk-free: Buy the same number of options as you buy shares in (1) and invest the
remaining money in a money market fund that pays r=0.50%. (Hint: You need to adjust the annual rate since your investment will last for only 6weeks. See latte return slides lecture 21)
c. What is the payoff and rate of return for each alternative (1-3) for the 3 BAC stock prices at the maturity of the options (1/14): 14.50, 15.50, and 16.50?Summarize your results in a table.
d. If the call options mature in-the-money what is the change in each strategy's payoff for an increase of 1 in the stock price (e.g. from 5.50 to 6.50)?
e. What are the minimum possible payoffs and returns for the three strategies?Which strategy is the most risky? Which one has the lowest amount of risk?
f. Find the break-even point for each strategy. That is, find the stock price at which the payoff at maturity is equal to 20,000.
g. You meet a colleague and point out that the strategy"options and risk-free"has excellent risk properties. Your colleague says: "Isn't that just like a protective put?" How do you respond?
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