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Suppose XYZ stock has a price of $50 and pays no dividends. The effective annual interest rate is 10%. (a) Draw payoff and profit diagrams
Suppose XYZ stock has a price of $50 and pays no dividends. The effective annual interest rate is 10%. (a) Draw payoff and profit diagrams for a long position in the stock. What is the profit of this position at a stock price in 1 year of $55 ? (b) Suppose you enter into a short 1-year forward position at a forward price of $50. Draw payoff and profit diagrams for this position. What is the payoff in 1 year for stock prices of $40,$45,$50, $55, and $60 ? (c) Suppose a default-free zero-coupon bond costs $90.9 and will pay $100 at maturity in 1 year. Draw the payoff and profit diagrams for the bond. (d) Suppose you enter into a forward position as in (b) and enter into a short position in the bond in (c). Draw payoff and profit diagrams for your net position. (e) [optional, not graded, but a useful thought experiment] Suppose XYZ paid a dividend of $2 per year and everything else stayed the same. Does that increase the benefit of investing in the stock? What about the forward contract? Why
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