Question 2

a) Suppose the price of oll is risky, with a beta of 1.2. The monthly storage cost per barrel is $20, paid at the end of each month, and the current spot price is $1,000. The expected rate of return on the market is 1.5% per month, with a risk-free rate of 0.5% per month. What is the expected price of oil per barrel in three months (in the absence of storage cost)? Suppose that you need a barrel of oil in three months. You believe that the price per barrel will rise to $1,080. Which of the following, in your view, would be cheaper overall: buying a barrel today or buying it in 3 months? [5 marks] b) Read the following statements. For each statement, first state whether it is true or false. Then explain your reasoning. i. There was no material information released about Alibaba's investment or profit on Monday. However, its share price rose by more than 10%. The fact that the stock market reacted to nothing suggests that it is not informationally efficient. [3 marks] ii. The only way for the financial market to be efficient is when every participant is fully rational. [3 marks] iii. Long call options are safer assets than stocks because the downside is limited. [3 marks] iv. There is a lot of empirical support for the CAPM. [3 marks] C) Consider the following butterfly spread using calls: go long one call with a low exercise price (90), short two calls with a medium strike (100) and long one call with a high exercise price (110). i. Show the payoff of this butterfly spread under different stock prices. You may ignore the purchase price. [3 marks] ii. What is a person who purchases this butterfly spread betting on? [2 marks] iii. Explain how you can achieve the same butterfly spread using puts only. You need to show the payoff under different stock prices as well. [3 marks] a) Suppose the price of oll is risky, with a beta of 1.2. The monthly storage cost per barrel is $20, paid at the end of each month, and the current spot price is $1,000. The expected rate of return on the market is 1.5% per month, with a risk-free rate of 0.5% per month. What is the expected price of oil per barrel in three months (in the absence of storage cost)? Suppose that you need a barrel of oil in three months. You believe that the price per barrel will rise to $1,080. Which of the following, in your view, would be cheaper overall: buying a barrel today or buying it in 3 months? [5 marks] b) Read the following statements. For each statement, first state whether it is true or false. Then explain your reasoning. i. There was no material information released about Alibaba's investment or profit on Monday. However, its share price rose by more than 10%. The fact that the stock market reacted to nothing suggests that it is not informationally efficient. [3 marks] ii. The only way for the financial market to be efficient is when every participant is fully rational. [3 marks] iii. Long call options are safer assets than stocks because the downside is limited. [3 marks] iv. There is a lot of empirical support for the CAPM. [3 marks] C) Consider the following butterfly spread using calls: go long one call with a low exercise price (90), short two calls with a medium strike (100) and long one call with a high exercise price (110). i. Show the payoff of this butterfly spread under different stock prices. You may ignore the purchase price. [3 marks] ii. What is a person who purchases this butterfly spread betting on? [2 marks] iii. Explain how you can achieve the same butterfly spread using puts only. You need to show the payoff under different stock prices as well. [3 marks]