Smiley Pty Ltd. shares currently trade at $4.20. An investor, Gerry enters into a call option on Smiley Pty Ltd shares with an exercise price of $4.50 per share in two months, and a premium of $0.20 per share.

a. In your own words define an option distinguishing between out of the money, in the money and at the money; explain the premium and the exercise price in relation to Smiley P/L. 5 marks

b. In the case of Smiley P/L, if Gerry were to take a straddle strategy, would this result with higher margins? In your own words, explain what a straddle consists of and provide two other strategies the company might consider in order to minmise any losses. 8 marks

c. A key objective of a derivative product is the management of any risk exposure. In your own words, explain how a derivative contract is able to achieve the risk management objective. 4 marks

d. A put option on a stock with a current price of $43 has an exercise price of $45. The price of the equivalent call option is $2.25. According to put-call parity, if the effective annual risk-free rate of interest is 3% and there are three months until expiration, what should be the price of the put? 3 marks