Problem 21-32

You would like to be holding a protective put position on the stock of XYZ Co. to lock in a guaranteed minimum value of $105 at year-end. XYZ currently sells for $105. Over the next year the stock price will increase by 9% or decrease by 9%. The T-bill rate is 7%. Unfortunately, no put options are traded on XYZ Co.

a. Suppose the desired put option were traded. How much would it cost to purchase?

Cost to purchase___________

b. What would have been the cost of the protective put portfolio?

Cost of the protective put portfolio__________

c. What portfolio position in stock and T-bills will ensure you a payoff equal to the payoff that would be provided by a protective put with X = 105? Show that the payoff to this portfolio and the cost of establishing the portfolio match those of the desired protective put.

Portfolio s=95.55 s= 114

Buy 0.5 shares _________ ________

Invest in T-bills _________ ________

Total _________ ________