eBook

Problem 14-04

You strongly believe that the price of Breener Inc. stock will rise substantially from its current level of $135, and you are considering buying shares in the company. You currently have $14,850 to invest. As an alternative to purchasing the stock itself, you are also considering buying call options on Breener stock that expire in three months and have an exercise price of $137. These call options cost $10 each.

1. Compare and contrast the size of the potential payoff and the risk involved in each of these alternatives. Do not round intermediate calculations. Round your answers to the nearest whole number.

   With $14,850 to spend, one could: Purchase shares of Breener Inc. stock Purchase call options

   Potential payoff is unlimited in -Select-case of purchasing sharescase of purchasing the stockboth casesItem 3 . Both the options will provide a -Select-higher lowerItem 4 percentage gain (loss) than purely purchasing stock.

2. Calculate the three-month rate of return on both strategies assuming that at the option expiration date Breener's stock price has (1) increased to $151 or (2) decreased to $130. Do not round intermediate calculations. Round your answers to two decimal places. Use a minus sign to enter negative values, if any. If the answer is zero, enter "0".

   1. Stock return: %

      Option return: %

   2. Stock return: %

      Option return: %

3. At what stock price level will the person who sells you the Breener call option break even? Assume that the call was uncovered. Round your answer to the nearest dollar.

   $