BFF5040 Tutorial Questions
Question based on week 1 topic due in week 2
T1Q1
You
are
attempting
to formulate
an
investment
strategy.
On
the
one
hand,
you
think
there
is
great
upward
potential
in
the
stock
market
and
would
like
to
participate
in
the
upward
move
if
it
materializes. However, you are not able to afford substantial stock market losses and so cannotrun the
risk of a stock market collapse, which you think is also a possibility. Your investmentadviser suggests
a protective put position: Buy both shares in a market index stock fund and putoptions on those shares
with 3-month expiration and exercise price of $780. The stock index fund is currently selling for $900.
However, your uncle suggests you instead buy a 3-month call option on the index fund with exercise
price $840 and buy 3-month T-bills with face value $840.
a.
On the same graph, draw the
payoffs
to each of these strategies as a function of the stock fund
value in 3 months. (Hint: Think of the options as being on one 鈥渟hare鈥?nbsp;of the stock
index fund,
with the current price of each share of the fund equal to $900.)
b.
Which portfolio must require a greater initial outlay to establish? (Hint: Does either portfolio
provide a final payout that is always at least as great as the payoff of the other portfolio?)
c.
Suppose the market prices of the securities are as follows:
Stock fund $900
T-bill (face value $840) $810
Call (exercise price $840) $120
Put (exercise price $780) $ 6
Make a table of the profits realized for each portfolio for the following values of the stock
price in 3 months: S
T
= $700, $840, $900, $960.
Graph the
profits
to each portfolio as a function of S
T
on a single graph.
d.
Which strategy is riskier? Which should have a higher beta?
e.
Explain
why
the
data
for
the
securities
given
in
part
(c)
do
not
violate
the
put-call
parity
relationship.
T1Q2
a.
Which type of order is often used together with
short sales
(sales of securities you don鈥焧 own
but have borrowed from your broker) to limit potential losses from the short position?
i.
Limit orders
ii.
Price-contingent orders
iii.
Stop-loss orders
iv.
Stop-buy orders
v.
Market orders
b.
Consider the following limit-order book for a share of stock of a specialist. The last trade in
the stock occurred at a price of $50.