Investments, 11th Edition (exclude Access Card)
Investments, 11th Edition (exclude Access Card)
11th Edition
ISBN: 9781260201543
Author: Zvi Bodie Professor; Alex Kane; Alan J. Marcus Professor
Publisher: McGraw-Hill Education
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Chapter 20, Problem 6PS

a.

Summary Introduction

To compute: The rate of return when the investment amount is completely invested in the stocks by the investor in one year.

Introduction:

Rate of return: When the annual income earned through an investment is expressed as a proportion in the form of percentage of the original investment, it is called as rate of return.

a.

Expert Solution
Check Mark

Answer to Problem 6PS

The table comparing the rate of return in percentages at different stock prices at maturity is as follows:

    ParticularsAmount (in $) when stock price is $80Amount (in $ ) when stock price is $100Amount (in $) when stock price is $110Amount (in $) when stock price is $120
    Rate of return in percentages-20%010%20%

Explanation of Solution

Stock price S0=$100

Call option with exercise price X=$100

Call option’s selling price C=$10

Call option’s expiration=1 year

Available amount for investment=$10000

Let us follow the following steps to calculation the rate of return.

Step 1: Calculation of investment amount:

  Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  1

So, therefore in each case of price variation at an expiry period of 1 year i.e., at, $80, $100, $110, $120 the investment amount will $10000.

Step 2: Calculation of profit/Loss in different maturity prices

    ParticularsAmount (in $) when stock price is $80Amount (in $ ) when stock price is $100Amount (in $) when stock price is $110Amount (in $) when stock price is $120
    Profit/ Loss per share when the current price is $100. (Stock price after 1 year − Current price)Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  2Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  3Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  4Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  5
    Profit/Loss per total sharesInvestments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  60Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  7Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  8

Step 3: Calculation of rate of return in different prices at maturity

Calculation of rate of return:

  Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  9

The same formula is used in calculations shown in the table.

    ParticularsAmount (in $) when stock price is $80Amount (in $ ) when stock price is $100Amount (in $) when stock price is $110Amount (in $) when stock price is $120
    Rate of returnInvestments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  100Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  11Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  12
    Rate of return in percentages (Rate of return *100)Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  130Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  14Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  15

The maximum profit earned is 20 % and maximum loss to be borne is -20% when all of the investment amount is invested in stocks by the investor.

b.

Summary Introduction

To compute: The rate of return when the investment amount is invested in the stock options.

Introduction:

Rate of return: When the annual income earned through an investment is expressed as a proportion in the form of percentage of the original investment, it is called as rate of return.

b.

Expert Solution
Check Mark

Answer to Problem 6PS

The table comparing the rate of return in percentages at different stock prices at maturity is as follows:

    ParticularsAmount (in $) when stock price is $80Amount (in $ ) when stock price is $100Amount (in $) when stock price is $110Amount (in $) when stock price is $120
    Rate of return in percentages-300%-100%0100%

Explanation of Solution

Stock price S0=$100

Call option with exercise price X=$100

Call option’s selling price C=$10

Call option’s expiration=1 year

Available amount for investment=$10000\

Let us follow the following steps to calculate the rate of return in this alternative.

Step 1: Calculation of investment amount:

  Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  16So, therefore in each case of price variation at an expiry period of 1 year i.e., at, $80, $100, $110, $120 the investment amount will $10000.

Step 2: Calculation of profit/loss in different maturity prices

Note1: Calculation of profit/loss for long call= Stock price at maturity − Strike Price- Option premium paid by the investor

    ParticularsAmount (in $) when stock price is $80Amount (in $ ) when stock price is $100Amount (in $) when stock price is $110Amount (in $) when stock price is $120
    Payoff per share when the strike price is $100. (Payoff=Stock price after 1 year − Strike price)Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  17Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  18Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  19Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  20
    Option premium per share paid by the investor10101010
    Profit/Loss per share (Note 1)Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  21Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  22Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  23Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  24
    Profit/Loss for 10 contractsInvestments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  25Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  260Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  27

Calculation of value of total contracts:

  Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  28

The same is used in all price variation cases in the above table.

Step 3: Calculation of rate of return:

  Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  29

The same formula is used in calculations shown in the table.

    ParticularsAmount (in $) when stock price is $80Amount (in $ ) when stock price is $100Amount (in $) when stock price is $110Amount (in $) when stock price is $120
    Rate of returnInvestments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  30Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  310Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  32
    Rate of return in percentages (Rate of return *100)Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  33Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  340Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  35

In this alternative, a maximum return of 100% and maximum loss to be borne is 300%. The reason is simple. It is a type of insurance contract where investor pays a premium and exercise the option only when required.

c.

Summary Introduction

To compute: The rate of return when $1000 is invested in options and $9000 is invested in money market fund paying 4% annual interest.

Introduction:

Money market fund: There are many types of securities in which the investment can be made. When the investor has the intention of investing in short term debt securities he/she can always opt for the money market fund. The money market fund is supposed to be an open-minded type of mutual fund. These are managed to maintain the net asset value’s stability at the highest point and at the same time pay the sufficient dividend to the investors in the form of dividends.

c.

Expert Solution
Check Mark

Answer to Problem 6PS

The combined weighted average rate of return at different stock prices at maturity is as follows:

    ParticularsAmount (in $) when stock price is $80Amount (in $ ) when stock price is $100Amount (in $) when stock price is $110Amount (in $) when stock price is $120
    Weighted average rate of return from options contract-30-10010
    Weighted average rate of return from money market fund3.603.63.63.6
    Total-26.40-6.403.6013.60

Explanation of Solution

Stock price S0=$100

Call option with exercise price X=$100

Call option’s selling price C=$10

Call option’s expiration=1 year

Available amount for investment=$10000

Let us follow the following steps to calculate the rate of return in this alternative

Step 1: Calculation of investment amount when $1000 is invested in options contract

  Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  36The same amount is applicable in all prices at maturity.

Step2: Calculation of Profit/Loss at different prices at maturity:

    ParticularsAmount (in $) when stock price is $80Amount (in $ ) when stock price is $100Amount (in $) when stock price is $110Amount (in $) when stock price is $120
    Payoff per share when the strike price is $100. (Payoff=Stock price after 1 year − Strike price)Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  37Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  38Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  39Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  40
    Option premium per share paid by the investor10101010
    Profit/Loss per share (Note 1)Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  41Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  42Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  43Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  44
    Profit/Loss for 1 contractsInvestments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  45Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  460Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  47

Calculation of value of total contracts:

  Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  48

The same is used in all price variation cases in the above table.

Step 3: Calculation of rate of return:

  Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  49

The same formula is used in calculations shown in the table.

    ParticularsAmount (in $) when stock price is $80Amount (in $ ) when stock price is $100Amount (in $) when stock price is $110Amount (in $) when stock price is $120
    Rate of returnInvestments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  50Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  510Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  52
    Rate of return (profit/loss amount) in percentages (Rate of return *100)Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  53Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  540Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  55

Step 4: Calculation of Weighted average rate of return- Note 2

  Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  56

Calculation of weighted average rate of return for option contract:

    ParticularsAmount (in $) when stock price is $80Amount (in $ ) when stock price is $100Amount (in $) when stock price is $110Amount (in $) when stock price is $120
    Weight of option contract investment Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  570.100.100.100.10
    Weighted average rate of return Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  58Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  59Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  600Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  61

Calculation of Profit/Loss of investment in money market fund at different price at maturity:

    ParticularsAmount (in $) when stock price is $80Amount (in $ ) when stock price is $100Amount (in $) when stock price is $110Amount (in $) when stock price is $120
    Return from money market fund Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  62360360360360
    Rate of return Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  630.040.040.040.04
    Rate of return in percentages (Rate of return *100)4444
    Weight of option contract investment Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  640.900.900.900.90
    Weighted average rate of return Investments, 11th Edition (exclude Access Card), Chapter 20, Problem 6PS , additional homework tip  653.603.63.63.6

Step5: Calculation of combined weighted average rate of return:

    ParticularsAmount (in $) when stock price is $80Amount (in $ ) when stock price is $100Amount (in $) when stock price is $110Amount (in $) when stock price is $120
    Weighted average rate of return from options contract-30-10010
    Weighted average rate of return from money market fund3.603.63.63.6
    Total-26.40-6.403.6013.60

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(d) Estimate the value of a share of Cisco common stock using the discounted cash flow (DCF) model as of July 27, 2019 using the following assumptions Assumptions Discount rate (WACC) Common shares outstanding 7.60% 5,029.00 million Net nonoperating obligations (NNO) $(8,747) million NNO is negative, which means that Cisco has net nonoperating investments CSCO ($ millions) DCF Model Reported 2019 Forecast Horizon 2020 Est. 2021 Est. 2022 Est. 2023 Est. Terminal Period Increase in NOA FCFF (NOPAT - Increase in NOA) $ 1241 1303 1368 10673 11207 11767 1437 $ 12354 302 ✓ Present value of horizon FCFF 9918 9679 9445 ✔ 0 × Cum. present value of horizon FCFF $ 0 × Present value of terminal FCFF 0 ☑ Total firm value 0 ☑ NNO -8747 ✓ Firm equity value $ 0 ☑ Shares outstanding (millions) 5029 Stock price per share $ 40.05
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