FIN4610 Group 9 (1)
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A risky stock is currently trading at $100 and its market value a year later will be
either $200 (if certain projects go well for the corporation) or $50 (if things turn out
bad for those important projects). There is a one-year zero-coupon bond available
with a par value $100 that currently trades for $90. Can you create a portfolio of the
stock and the bond that will replicate the payoff of a call option on the stock with
strike $100 and expiry in 1 year? Then, can you price the call? Explain carefully how
will you do all this.
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Related Questions
Suppose the current stock price is $50 and you believe that, one year from now,
the stock will sell for either $60 (up-state) or $30 (down-state). The yield on a 1-year risk
free zero coupon bond is currently 4%. If you want to replicate a call option payoff with
an exercise price of $40, how much should you borrow today? (SHOW YOUR WORK)
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Stock Y is currently selling for $35. You believe that, one year from now, Stock Y will sell for either $65 (up-state) or $25 (down-state). The yield on a 1-year risk-free zero coupon bond is currently 2.5%. You have a European call option with a 1-year expiration date and an exercise price of $40. If you where to create a strategy that replicates this option, how many shares would you need to buy (shortsell if negative)? In other words, what is the call option delta?
arrow_forward
This example is part of "Hedged Portfolios" to minimize risk.
Assume you have $7000 to invest; A stock is trading at $100.00.
A call option that expires in one year with a strike price of $100.00 is trading at $8.00.
How much is your portfolio's 1-year return if you invest in "Only Options" and the stock price after one year is $54.00?
Enter your answer in the following format: + or - 0.1234
Hint: The Answer is between -0.89 and -1.08
arrow_forward
You have two options to invest $1000 in:
A $1050 face value bond with coupon rate c =
i)
ii)
= 6%.
A stock portfolio that you aim to resell at $1100 after receiving a dividend of $50.
Then answer the following:
a) Which of the two options makes you the highest rate of return?
b) Is there any reason why would you want to choose the other?
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You now face the choice of investing it in a U.S. Treasury bond that will return $633,000 at the end of a year or a common stock that has a 50-50 chance of being worthless or worth $1,380,000 at the end of the year.
The expected rate of return on the T-bond investment is 5.5%. What is the expected rate of return on the stock investment? Round your answer to the nearest whole number.
arrow_forward
Suppose the current stock price is $50 and you believe that, one year from now, the stock will sell for either $60 (up-state) or $30 (down-state). The yield on a 1-year risk-free zero coupon bond is currently 4%. You have a European put option with a 1-year expiration date and an exercise price of $40. The call option price with the same exercise price with the same maturity date is $14.10. What would be the put option price? (SHOW YOUR WORK)
arrow_forward
I need help on this pls and as soon as possible:
C. A coupon bond has a face value of $ 1,000, remaining maturity of 10 years, a 5% annuallypaid coupon, and a market interest rate of 4%.
(1) What is the current price for the above bond? (2) Even though the bonds of a corporation are less risky than equity, investors still haverisks. Please discuss potential risks that investors face.
arrow_forward
Stock Z is currently selling for $120. You believe that, one year from now, Stock Z will sell for either $155 (up-state) or $85 (down-state). The yield on a 1-year risk-free zero coupon bond is currently 4%. You have a European put option with a 1-year expiration date and an exercise price of $115. What is this option's delta (Δ) ?
arrow_forward
A call option has X=$52 and expire in 360 days (suppose we have 360 days in one year). The risk-free rate is 4%. The call is priced at $11. A put option has X-$52 and is priced
at $1. The underlying asset is priced at S0=$43. Suppose in our investments, we could involve one call, one put, one bond, and on stock. How much arbitrage profit could we
possibly obtain?
arrow_forward
Maria VanHusen, CFA, suggests that using forward contracts on fixed-income securities can be used to protect the value of the Star Hospital Pension Plan’s bond portfolio against the possibility of rising interest rates. VanHusen prepares the following example to illustrate how such protec-tion would work:∙ A 10-year bond with a face value of $1,000 is issued today at par value. The bond pays an annual coupon.∙ An investor intends to buy this bond today and sell it in 6 months.∙ The 6-month risk-free interest rate today is 5% (annualized).∙ A 6-month forward contract on this bond is available, with a forward price of $1,024.70.∙ In 6 months, the price of the bond, including accrued interest, is forecast to fall to $978.40 as a result of a rise in interest rates.a. Should the investor buy or sell the forward contract to protect the value of the bond against rising interest rates during the holding period?b. Calculate the value of the forward contract for the investor at the maturity of…
arrow_forward
You own a $1,000-par zero-coupon bond that has 5 years of remaining maturity.You plan on selling the bond in one year and believe that the required yield next year will have the following probability distribution in the table highlighted in yellow color.2a. What is your expected price when you sell the bond?2b. What is the standard deviation?
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Please help with this question with full working out.
arrow_forward
Your broker has developed a list of firms, their betas, and the return he
expects the stock to yield over the next twelve months (labeled
"Expected Return"). You have estimated that the risk-free rate is 5% and
the return to the market will be 12%. Assuming that CAPM is correct,
which stock should you purchase?
Anderson, Inc.
Nathan's Bakeries
Z-man Electronics
Delta Vanlines
All of the stocks
Beta Expected
Return
Anderson, Inc. 0.90
10.5%
Delta Vanlines 1.10 13.0%
1.60 16.0%
Firm
Nathan's
Bakeries
Z-man
Electronics
2.15 19.0%
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what is the expected return and should you buy it?
arrow_forward
You are a financial manager and you have bonds worth $3,000,000 in your portfolio which have a 7 % coupon rate and will be maturing in 10 years from now.
What type of risk exposure do you face on these bonds? Suppose a futures contract on these bonds is available with a standard contract size of US$300,000 per contract.
How will you hedge your exposure? If the market interest rates change to 9 %, what will be your position?
Kindly, show calculations on how you arrive at your answer.
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2) As an investor, you are considering an investment in the bonds of the Soccer
Company. The bonds, which pay interest semiannually, will mature in ten years, and
have a coupon rate of 6.5% on a face value of $1,000.
a) Assume your required return is 8% (market rate) for the bonds in this risk class,
what is the highest price you would be willing to pay for the bond? (Use the PV
function)
b) What is the current yield of these bonds?
c) If you bought the bond at the above calculated price and hold the bonds for one
year, what total rate of return will you earn (assuming the market rate does not
change)?
Hint: You need to calculate the bond price one year ahead (note: in one year 9
years are left to maturity) and then compute the total return based on the capital
gains/loss yield (in %) and the current yield (in %) from b).
d) What is the yield to maturity on these bonds if you purchase them at the price
calculated under a)? (Use the RATE function)
e) If the bonds can be called in three…
arrow_forward
You are a financial manager, and you have bonds worth $1,550,000 in yourportfolio which have a 7 percent coupon rate and will be maturing in 10years from now. The market rate is also 7 percent but is likely to eitherrise to 8% or fall to 6%Based on the above information, answer the following questions:i) What type of risk you are exposed to?
ii) How can you hedge your exposure using the information in partsiii) and iv) below?
iii) Suppose a call and put option on these bonds is available withan exercise price of $1,700,000. These contracts are availablein standard contract sizes of 100 options per contract at aprice of $5 per contract. Show the net impact of a change inmarket rates if options are used for hedging the exposure.
iv) If a futures contract on these bonds is available with a standardcontract size of $155,000 per contract, show what will be thenet impact of a change in market rates if futures are used forhedging the exposure.
v) Which hedge provides better results? Why?
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Assume the zero-coupon yields on default-free securities are as summarized in the following table: (Click on the
following icon in order to copy its contents into a spreadsheet.)
Maturity (years)
Zero-coupon YTM
1
6.30%
2
6.90%
3
7.30%
4
7.70%
5
8.00%
What is the price of a three-year, default-free security with a face value of $1,000 and an annual coupon rate of 8%?
What is the yield to maturity for this bond?
What is the price of a three-year, default-free security with a face value of $1,000 and an annual coupon rate of 8%?
The price is $1894.57. (Round to the nearest cent.)
arrow_forward
A stock has not been fluctuating much in price. Its average price is $20/share. You expect that the stock price
behaves the same way in the next year. A one-year put option is selling for $5, which has an exercise price of $20.
Suppose the risk-free rate is 0.05.
To make use of your expectation in the future price movement, you establish a straddle strategy to maximize your
profits.
If the stock price actually ends up at $20 in a year, your profit is $
. Give your answer to 2 decimal places.
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Suppose you purchase a 30-year Treasury bond with a 5% annual coupon, initially trading at par. In 10 years' time, the bond's yield to maturity has risen to 7% (EAR).
(Assume $100 face value bond.)
a. If you sell the bond now, what internal rate of return will you have earned on your investment in the bond?
b. If instead you hold the bond to maturity, what internal rate of return will you earn on your initial investment in the bond?
c. Is comparing the IRRs in (a) versus (b) a useful way to evaluate the decision to sell the bond? Explain.
a. If you sell the bond now, what internal rate of return will you have earned on your investment in the bond?
The IRR of the bond is %. (Round to two decimal places.)
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a) You are considering two bonds A and B; Bond A has a 9% annual coupon rate while Bond B has a 6% annual coupon payment. Both bonds have YTM of 7, which is expected to remain constant over their life of 7 years. What will be the price path of two bonds? Please explain it with respect to the graph of bond price path.
b) A highly risk-averse investor is considering adding one additional stock to a 4-stock portfolio. Two stocks are under consideration. Both have an expected return,, of 15%. However, the distribution of possible returns associated with Stock A has a standard deviation of 12%, while Stock B’s standard deviation is 8%. Both stocks are equally highly correlated with the market, with correlation equal to 0.75 for both stocks. Which stock should this risk-averse, will add to his/her portfolio? Explain with reasoning
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suppose you purchase a
30-year
Treasury bond with a
5%
annual coupon, initially trading at par. In
10
years' time, the bond's yield to maturity has risen to
6%
(EAR). (Assume
$100
face value bond.)
a. If you sell the bond now, what internal rate of return will you have earned on your investment in the bond?
b. If instead you hold the bond to maturity, what internal rate of return will you earn on your initial investment in the bond?
c. Is comparing the IRRs in
(a)
versus
(b) a useful way to evaluate the decision to sell the bond? Explain.
1. If you sell the bond now, what internal rate of return will you have earned on your investment in the bond?
The IRR of the bond is
nothing%.
(Round to two decimal places.)
arrow_forward
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Related Questions
- Suppose the current stock price is $50 and you believe that, one year from now, the stock will sell for either $60 (up-state) or $30 (down-state). The yield on a 1-year risk free zero coupon bond is currently 4%. If you want to replicate a call option payoff with an exercise price of $40, how much should you borrow today? (SHOW YOUR WORK)arrow_forwardStock Y is currently selling for $35. You believe that, one year from now, Stock Y will sell for either $65 (up-state) or $25 (down-state). The yield on a 1-year risk-free zero coupon bond is currently 2.5%. You have a European call option with a 1-year expiration date and an exercise price of $40. If you where to create a strategy that replicates this option, how many shares would you need to buy (shortsell if negative)? In other words, what is the call option delta?arrow_forwardThis example is part of "Hedged Portfolios" to minimize risk. Assume you have $7000 to invest; A stock is trading at $100.00. A call option that expires in one year with a strike price of $100.00 is trading at $8.00. How much is your portfolio's 1-year return if you invest in "Only Options" and the stock price after one year is $54.00? Enter your answer in the following format: + or - 0.1234 Hint: The Answer is between -0.89 and -1.08arrow_forward
- You have two options to invest $1000 in: A $1050 face value bond with coupon rate c = i) ii) = 6%. A stock portfolio that you aim to resell at $1100 after receiving a dividend of $50. Then answer the following: a) Which of the two options makes you the highest rate of return? b) Is there any reason why would you want to choose the other?arrow_forwardYou now face the choice of investing it in a U.S. Treasury bond that will return $633,000 at the end of a year or a common stock that has a 50-50 chance of being worthless or worth $1,380,000 at the end of the year. The expected rate of return on the T-bond investment is 5.5%. What is the expected rate of return on the stock investment? Round your answer to the nearest whole number.arrow_forwardSuppose the current stock price is $50 and you believe that, one year from now, the stock will sell for either $60 (up-state) or $30 (down-state). The yield on a 1-year risk-free zero coupon bond is currently 4%. You have a European put option with a 1-year expiration date and an exercise price of $40. The call option price with the same exercise price with the same maturity date is $14.10. What would be the put option price? (SHOW YOUR WORK)arrow_forward
- I need help on this pls and as soon as possible: C. A coupon bond has a face value of $ 1,000, remaining maturity of 10 years, a 5% annuallypaid coupon, and a market interest rate of 4%. (1) What is the current price for the above bond? (2) Even though the bonds of a corporation are less risky than equity, investors still haverisks. Please discuss potential risks that investors face.arrow_forwardStock Z is currently selling for $120. You believe that, one year from now, Stock Z will sell for either $155 (up-state) or $85 (down-state). The yield on a 1-year risk-free zero coupon bond is currently 4%. You have a European put option with a 1-year expiration date and an exercise price of $115. What is this option's delta (Δ) ?arrow_forwardA call option has X=$52 and expire in 360 days (suppose we have 360 days in one year). The risk-free rate is 4%. The call is priced at $11. A put option has X-$52 and is priced at $1. The underlying asset is priced at S0=$43. Suppose in our investments, we could involve one call, one put, one bond, and on stock. How much arbitrage profit could we possibly obtain?arrow_forward
- Maria VanHusen, CFA, suggests that using forward contracts on fixed-income securities can be used to protect the value of the Star Hospital Pension Plan’s bond portfolio against the possibility of rising interest rates. VanHusen prepares the following example to illustrate how such protec-tion would work:∙ A 10-year bond with a face value of $1,000 is issued today at par value. The bond pays an annual coupon.∙ An investor intends to buy this bond today and sell it in 6 months.∙ The 6-month risk-free interest rate today is 5% (annualized).∙ A 6-month forward contract on this bond is available, with a forward price of $1,024.70.∙ In 6 months, the price of the bond, including accrued interest, is forecast to fall to $978.40 as a result of a rise in interest rates.a. Should the investor buy or sell the forward contract to protect the value of the bond against rising interest rates during the holding period?b. Calculate the value of the forward contract for the investor at the maturity of…arrow_forwardYou own a $1,000-par zero-coupon bond that has 5 years of remaining maturity.You plan on selling the bond in one year and believe that the required yield next year will have the following probability distribution in the table highlighted in yellow color.2a. What is your expected price when you sell the bond?2b. What is the standard deviation?arrow_forwardPlease help with this question with full working out.arrow_forward
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Recommended textbooks for you
- Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning

Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
