Question
Problem 22-28 Two-State Option Pricing Model Maverick Manufacturing, Inc., must purchase gold in three months for use in its operations. Mavericks management has estimated that
Problem 22-28 Two-State Option Pricing Model
Maverick Manufacturing, Inc., must purchase gold in three months for use in its operations. Mavericks management has estimated that if the price of gold were to rise above $1,585 per ounce, the firm would go bankrupt. The current price of gold is $1,505 per ounce. The firms chief financial officer believes that the price of gold will either rise to $1,715 per ounce or fall to $1,395 per ounce over the next three months. Management wishes to eliminate any risk of the firm going bankrupt. Maverick can borrow and lend at the risk-free EAR of 5.0 percent. |
a-1. | Should the company buy a call option or a put option on gold? | ||||
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a-2 | What strike price would the company like this option to have? (Do not round intermediate calculations.) |
Strike price |
b. | How much should such an option sell for in the open market? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) |
Option price | $ |
c. | Suppose no options currently trade on gold. What are the transactions needed to create a synthetic option with identical payoffs to a traded option? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16)) |
c-1. (Click to select)BuySell | $ shares of stock |
c-2. Amount to (Click to select)borrowlend | $ |
d. | How much does the synthetic option cost? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) |
Synthetic option | $ |
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