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Please answer one of the following questions in detail, providing examples whenever applicable.

1. Discuss the risks and payoffs of the following positions, accompanied by payoff graphs.

· Buy stock and a put option on the stock.

· Buy a stock.

· Buy a call.

· Buy stock and sell a call option on the stock (covered call).

· Buy a bond.

· Buy stock, buy a put, and sell a call.

· Sell a put (naked put).


-OR-

2. Over the coming year, Ragwort’s stock price might drop from $100 to $50, or it might rise to $200. The one-year interest rate is 10%. 

· What is the delta of a one-year call option on Ragwort stock with an exercise price of $100?

· Use the replicating-portfolio method to value this call. 

· In a risk-neutral world, what is the probability that Ragwort stock will rise in price? 

· Use the risk-neutral method to check your valuation of the Ragwort option. 

· If someone told you that, in reality, there is a 60% chance that Ragwort’s stock price will rise to $200, would you change your view about the value of the option? Explain.