can you answer those questions?

USC Marshall School of Business Financial Risk Management Scott Joslin FBE 559 Spring 2014 Quiz #7/Case Assignment Speculating on an Acquisition with Options: RJR Nabisco (Due: Tuesday April 29th, in class) This take-home (open book) case assignment will serve as Quiz #7. You may complete this assignment in groups of 1-4 people; submit one copy for the entire group. Each group member will receive the same grade. Problem 1 Write down the put-call parity relationship for American options on a stock paying a lumpy (dollar) dividend. Examine the February 95-strike options. Is there an arbitrage opportunity? Problem 2 What path will the stock price follow if KKR's oer is successful? If it isn't? Problem 3 Ignore early exercise, that is, assume all options are European. When will John's proposed put-call parity strategy work, when won't it work? Problem 4 When (at what date and for which price) will the call and the put be exercised? How does early exercise impact the put-call parity strategy? Problem 5 Try to construct a security or new 'derivative' which closely resembles a pure bet on the takeover succeeding. For this question you can assume that you can trade any of the February options listed in Exhibit 1. 1 In these problems, assume that: If KKR's oer is successful, then 73.39% of outstanding shares are acquired for $109. The residual shares continue to trade on the stock exchange as before, at a price of $85 as predicted by analysts. Similarly, the options continue to trade on the Chicago Board Options Exchange with no change in their terms. It is possible to shortsell RJR Nabisco shares for any length of time. However, note that current RJR Nabisco shareholders lending their shares to shortsellers will need to be fully compensated for any eects of the tender oer, if it succeeds, when the shares are returned (that is, they need to be no worse or better o for having lent their shares). Hint: Imagine you own 100 RJR Nabisco shares which you agree to lend to shortsellers. What would you require? The continuously compounded interest rate is 9% per year. 2