CORPORATE FINANCE - CONNECT ACCESS
12th Edition
ISBN: 9781264054893
Author: Ross
Publisher: MCG
expand_more
expand_more
format_list_bulleted
Videos
Textbook Question
Chapter 22, Problem 1CQ
Options What is a call option? A put option? Under what circumstances might you want to buy each? Which one has greater potential profit? Why?
Expert Solution & Answer
Summary Introduction
To determine: The meaning of call option, put option, circumstances under which they might be bought and whether call option or put option has greater potential profit.
Option:
Option refers to the formal contract between the issuer and buyer that provides right to buy or right to sell and not the obligation for a specific property or a commodity at a specified time period.
Answer to Problem 1CQ
- A call option is which does not carry any obligation on the right given to an individual to ‘purchase’ an asset at any particular price fixed or given point of time.
- A put option is the option which does not carry any obligation on the right given to an individual to ‘sell’ an asset at a particular fixed price on given point of time.
- When an increase in the price of the underlying asset is projected then it would be beneficial to buy a call option and when a decrease in the underlying asset is expected then purchase of put option is beneficial.
- Greater potential profit can happened in either of the cases depending upon the increase or decrease in the value of the underlying asset.
Explanation of Solution
- The call option is the option that provides a right not an obligation to sell an underlying asset anytime before expiration. So, when the price of the asset is increased over the period the buyer can be benefited by selling the asset at her price and when it is deceased he can choose not to sell and continue with holding it.
- The put option is the option that provides a right not an obligation to buy an underlying asset anytime before expiration. Son, when the price of the asset is decreased over the period, the buyer can be benefited by purchasing the asset at lower cost.
- The call option and put option both have similar potential profit depending upon the change in the value of the underlying asset, greater increase in asset would increase the potential profit in call option and greater decrease in asset would increase the potential profit in put option.
Conclusion
Thus, the potential profit in call and put option depends upon the change in the price of the underlying asset.
Want to see more full solutions like this?
Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!
Students have asked these similar questions
Depreciation A firm is evaluating the acquisition of an asset that costs $68,400 and requires $3,990 in installation costs. If the firm depreciates the
asset under MACRS, using a five-year recovery period (see table |), determine the depreciation charge for each year.
The annual depreciation expense for year 1 will be $
The annual depreciation expense for year 2 will be $
The annual depreciation expense for year 3 will be $
The annual depreciation expense for year 4 will be $
The annual depreciation expense for year 5 will be $
The annual depreciation expense for year 6 will be $
(Round to the nearest dollar.)
(Round to the nearest dollar.)
(Round to the nearest dollar.)
(Round to the nearest dollar.)
(Round to the nearest dollar.)
(Round to the nearest dollar.)
Integrative Risk and valuation Giant Enterprises' stock has a required return of 15.9%. The company, which plans to pay a dividend of $2.22 per
share in the coming year, anticipates that its future dividends will increase at an annual rate consistent with that experienced over 2016-2022 period,
when the following dividends were paid:
a. If the risk-free rate is 6%, what is the risk premium on Giant's stock?
b. Using the constant-growth model, estimate the value of Giant's stock. (Hint: Round the computed dividend growth rate to the nearest
whole percent.)
c. Explain what effect, if any, a decrease in the risk premium would have on the value of Giant's stock.
a. If the risk-free rate is 6%, the risk premium on Giant's stock is
%. (Round to one decimal place.)
(Round to the nearest cent.)
b. Using the constant-growth model, the value of Giant's stock is $
c. Explain what effect, if any, a decrease in the risk premium would have on the value of Giant's stock. (Select from the drop-down…
Bond valuation-Semiannual interest Find the value of a bond maturing in 4 years, with a $1,000 par value and a coupon interest rate of 9%
(4.5% paid semiannually) if the required return on similar-risk bonds is 13% annual interest.
The present value of the bond is $
(Round to the nearest cent.)
Chapter 22 Solutions
CORPORATE FINANCE - CONNECT ACCESS
Ch. 22 - Options What is a call option? A put option? Under...Ch. 22 - Options Complete the following sentence for each...Ch. 22 - American and European Options What is the...Ch. 22 - Intrinsic Value What is the intrinsic value of a...Ch. 22 - Option Pricing You notice that shares of stock in...Ch. 22 - Options and Stock Risk If the risk of a stock...Ch. 22 - Option Risk True or false: The unsystematic risk...Ch. 22 - Prob. 8CQCh. 22 - Option Price and Interest Rates Suppose the...Ch. 22 - Contingent Liabilities When you take out an...
Ch. 22 - Options and Expiration Dates What is the impact of...Ch. 22 - Options and Stock Price Volatility What is the...Ch. 22 - Insurance as an Option An insurance policy is...Ch. 22 - Equity as a Call Option It is said that the equity...Ch. 22 - Prob. 15CQCh. 22 - Put Call Parity You find a put and a call with the...Ch. 22 - Put- Call Parity A put and a call have the same...Ch. 22 - Put- Call Parity One thing put-call parity tells...Ch. 22 - Prob. 1MCCh. 22 - Prob. 2MCCh. 22 - Prob. 3MCCh. 22 - Prob. 4MCCh. 22 - Prob. 5MC
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Yield to maturity The relationship between a bond's yield to maturity and coupon interest rate can be used to predict its pricing level. For the bond listed below, state whether the price of the bond will be at a premium to par, at par, or at a discount to par. Coupon interest rate 6% Yield to maturity 11% What is the price of the bond in relation to its par value? (Select the best answer below.) ○ A. The bond sells at a discount to par. B. The bond sells at a premium to par. OC. The bond sells at par.arrow_forwardBook value Find the book value for the asset shown in the accompanying table, assuming that MACRS depreciation is being used Elapsed time Recovery Asset A Installed cost $903,000 period (years) 5 since purchase (years) 4 The remaining book value is $ (Round to the nearest dollar.)arrow_forwardCommon stock value: Constant growth The common stock of Barr Labs Inc., trades for $111 per share. Investors expect the company to pay a(n) $1.43 dividend next year, and they expect that dividend to grow at a constant rate forever. If investors require a(n) 15.5% return on this stock, what is the dividend growth rate that they are anticipating? The anticipated dividend growth rate is %. (Round to two decimal places.)arrow_forward
- Choosing between two projects with acceptable payback periods Shell Camping Gear, Inc., is considering two mutually exclusive projects. Each requires an initial investment of $100,000. John Shell, president of the company, has set a maximum payback period of 4 years. The cash inflows associated with each project are shown in the following table: a. Determine the payback period of each project. b. Which project is acceptable based on payback period? a. The payback period of project A is years. (Round to two decimal places.) The payback period of project B is years. (Round to two decimal places.) b. Which project is acceptable based on payback period? (Select the best answer below.) ○ Project A would be preferred over project B because the larger cash flows are in the later years of the project. ○ Project B would be preferred over project A because the larger cash flows are in the early years of the project.arrow_forwardWeekend Warriors, Inc., has 35% debt and 65% equity in its capital structure. The firm's estimated after-tax cost of debt is 5% and its estimated cost of equity is 13%. Determine the firm's weighted average cost of capital (WACC). Weekend Warriors' weighted average cost of capital (WACC) is %. (Round to two decimal places.)arrow_forwardInitial cash flow: Basic calculation Cushing Corporation is considering the purchase of a new grading machine to replace the existing one. The existing machine was purchased 4 years ago at an installed cost of $20,700; it was being depreciated under MACRS using a 5-year recovery period. (See table for the applicable depreciation percentages.) The existing machine is expected to have a usable life of at least 5 more years. The new machine costs $36,000 and requires $5,100 in installation costs; it will be depreciated using a 5-year recovery period under MACRS. The existing machine can currently be sold for $24,500 without incurring any removal or cleanup costs. The firm is subject to a 21% tax rate. Calculate the initial cash flow associated with the proposed purchase of a new grading machine. The initial cash flow will be $ (Round to the nearest dollar.)arrow_forward
- Yield to maturity The Salem Company bond currently sells for $1,237.92, has a coupon interest rate of 15% and a $1000 par value, pays interest annually, and has 15 years to maturity. a. Calculate the yield to maturity (YTM) on this bond. b. Explain the relationship that exists between the coupon interest rate and yield to maturity and the par value and market value of a bond. a. The yield to maturity on this bond is %. (Round to three decimal places.) b. Explain the relationship that exists between the coupon interest rate and yield to maturity and the par value and market value of a bond. (Select the best answer below.) ○ A. The market value of the bond approaches its par value as the time to maturity increases. The yield to maturity approaches the coupon interest rate as the time to maturity increases. B. The market value of the bond approaches its par value as the time to maturity declines. The yield to maturity approaches the coupon interest rate as the time to maturity declines. ○…arrow_forwardPreferred stock valuation Jones Design wishes to estimate the value of its outstanding preferred stock. The preferred issue has a par value of $60 and pays an annual dividend of $6.70 per share. Similar-risk preferred stocks are currently earning an annual rate of return of 7.7%. a. What is the market value of the outstanding preferred stock? b. If an investor purchases the preferred stock at the value calculated in part a, how much does she gain or lose per share if she sells the stock when the required return on similar-risk preferred stocks has risen to 9.5%? a. The market value of the outstanding preferred stock is $ per share. (Round to the nearest cent.) per share. (Round to the nearest cent.) b. If the required return on similar-risk preferred stocks has risen to 9.5%, the value of the stock will be $ If an investor purchased the preferred stock at the value calculated in part a and sells the stock when the required return on similar-risk preferred stocks has risen to 9.5%, the…arrow_forwardRetained earnings versus new common stock Using the data for a firm shown in the following table, calculate the cost of retained earnings and the cost of new common stock using the constant-growth valuation model. (Click on the icon here in order to copy the contents of the data table below into a spreadsheet.) Current market Dividend price per share growth rate $54.00 7% Projected dividend per share next year $2.16 a. The cost of retained earnings is ☐ %. (Round to two decimal places.) b. The cost of new common stock is %. (Round to two decimal places.) Underpricing per share $2.00 Flotation cost per share $2.25arrow_forward
- Bond interest payments before and after taxes Charter Corp. issued 1,877 debentures with a $1,000 par value and 5% coupon rate. a. What dollar amount of interest per bond can an investor expect to receive each year from Charter? b. What is Charter's total interest expense per year associated with this bond issue? c. Assuming that Charter pays a 21% corporate tax, what is the company's net after-tax interest cost associated with this bond issue? (Round to the nearest dollar.) (Round to the nearest dollar.) a. The dollar amount of interest per bond an investor can expect to receive each year from Charter is $ b. Charter's total interest expense per year associated with this bond issue is $ c. Assuming that Charter is in a 21% corporate tax bracket, the company's net after-tax interest cost associated with this bond issue is $ to the nearest dollar.) (Roundarrow_forwardAfter-tax cost of debt Personal Finance Problem Bella Wans is interested in buying a new motorcycle. She has decided to borrow the money to pay the $20,000 purchase price of the bike. She is in the 35% income tax bracket. She can either borrow the money at an interest rate of 4% from the motorcycle dealer, or she could take out a second mortgage on her home. That mortgage would come with an interest rate of 9%. Interest payments on the mortgage would be tax deductible for Bella, but interest payments on the loan from the motorcycle dealer could not be deducted on Bella's federal tax return. a. Calculate the after-tax cost of borrowing from the motorcycle dealership. b. Calculate the after-tax cost of borrowing through a second mortgage on Rella's home a. The after-tax cost of borrowing from the motorcycle dealership is %. (Round to the nearest whole percentage.) b. The after-tax cost of borrowing through a second mortgage is %. (Round to two decimal places.) c. Which source of…arrow_forwardOxy Corporation uses debt, preferred stock, and common stock to raise capital. The firm's capital structure targets the following proportions: debt, 53%; preferred stock, 17%; and common stock, 30%. If the cost of debt is 7.2%, preferred stock costs 9.4%, and common stock costs 11.3%, what is Oxy's weighted average cost of capital (WACC)? Oxy's weighted average cost of capital (WACC) is %. (Round to two decimal places.)arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT
Accounting for Derivatives Comprehensive Guide; Author: WallStreetMojo;https://www.youtube.com/watch?v=9D-0LoM4dy4;License: Standard YouTube License, CC-BY
Option Trading Basics-Simplest Explanation; Author: Sky View Trading;https://www.youtube.com/watch?v=joJ8mbwuYW8;License: Standard YouTube License, CC-BY