BUSFIN 1030 Introduction to Finance XXXXXXXXXXTuesdays 5:45 – 8:10 p Corporate Finance EXAM 3&4 Complete and submit Exam 34 by 11:00 PM on Sunday, May 3. No late submissions will be considered for a...

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Answered Same DayApr 27, 2021

Answer To: BUSFIN 1030 Introduction to Finance XXXXXXXXXXTuesdays 5:45 – 8:10 p Corporate Finance EXAM 3&4...

Kushal answered on May 02 2021
157 Votes
Question 1
A.
We can use the Black Scholes model for the pricing of the European call and put options. We can use the binomial lattice structure but we need risk neutral probabilities for the same which are currently missi
ng.
Black scholes model for call optio–
C=St​*N(d1​)−X*e^−rt * N(d2​)
d1 = (ln ( St / X) + (r + sigma^2 /2) * t ) / sigma * t ^ 0.5
d2 = d1 – sigma * t ^ 0.5
St = 26.74 ( As on 1st may )
X = 35
t = 0.5
r = 0.14% ( 6 month treasury yield as on 1st May)
sigma = 110%
d1 = (-0.269 + 0.303) / 0.777 = 0.044
d2 = 0.45 – 0.777 = -0.0734
C = 26.74 * 0.517 – 35 * 0.231 * 0.999 = 5.74
Put option price –
D1 = 0.476
D2 = -0.302
p= X*e^−rt * N(-d2​) - St​*N(-d1​)
p = 25 * 0.999 * 0.618 – 26.74 * 0.317 = 6.9
    
B.
We can buy a long call option and buy a long put option. This can be done for the same strike price and same maturity or different strike price same maturity. This will either create a straddle or a strangle position. This strategy does benefit from the wild movements in the underlying and loses when the underlying does not move.
Hence, the correct answer is the combination of a and b. We will but both call and put options.
C.
    Possible UAL price in 6 months:
    $3
    $34
    $85
    How much money will you receive (+) or pay (-) from your strategy today?
    -12.72
    -12.72
    -12.72
    How much money will you receive (+) or pay (-) from your strategy 6 months from today (i.e. when you may or may not exercise options, liquidate the stock position IF it was a part of your strategy, etc.)?
    16.26
    0
    $50
     
     
     
     
    Ultimate profit/loss of your trading strategy (after you consider ALL cash inflows/outflows both today and 6 months from today)*
    3.54
    -12.72
    37.28
Here, in all the three different scenarios of prices, we are employing a buy call and a buy strategy. Hence, the initial investment will remain the same.
Investment = p + c = 6.98 + 5.74 = 12.72
In scenario where the price goes down to $ 3, the call option wont be exercised and only put will be exercised.
Put payoff = 25 -3 = 22
Total profit = 22 – 12.72 = 9.28
In scenario where the price goes down to $ 3, the call option and put both the options will not be exercised.
Total losses = -12.72
In scenario...
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