Investments Final
An analyst has determined that the intrinsic value of HPQ stock is $20 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 25, then it would be reasonable to assume the expected EPS of HPQ in the coming year is
$0.80 =$20(1/25) = $0.80
What is the price of a 4-year maturity bond with a 10% coupon rate paid annually? (Par value = $1,000.) Year 1: $925.16 Year 2: $862.57 Year 3: $788.66 Year 4: $711.00
$1,039.90 Instead of discounting all coupons at the 4 year YTM (8.9%), we should discount each coupon with the interest rate that have the same maturity as the coupon Price = 100/1.08 +100/(1.077)^2 +100/(1.082)^3 +1100/(1.089)^4 =1039.9
Other things equal, the price of a stock call option is positively correlated with which of the following factors?
-The stock price, time to expiration, and stock volatility -The exercise price is negatively correlated with the call option price.
The maximum loss a buyer of a stock call option can suffer is equal to
-a call premium -If an option expires worthless, all the buyer has lost is the price of the contract (premium).
Consider two bonds, A and B. Both bonds presently are selling at their par value of $1,000. Each pays interest of $120 annually. Bond A will mature in five years, while bond B will mature in six years. If the yields to maturity on the two bonds change from 12% to 10%,
-both bonds will increase in value, but bond B will increase more than bond A. -The longer the maturity, the greater the price change when interest rates change.
An American call option allows the buyer to
-buy the underlying asset at the exercise price on or before the expiration date. -American option can be exercised at any time before expiration
According to the expectations hypothesis, an upward sloping yield curve implies that
-interest rates are expected to increase in the future. -An upward sloping yield curve is based on the expectation that short-term interest rates will increase.
The value of a stock put option is positively related to
-time to expiration and strike price -The time to expiration and striking price are positively related to the value of a put option; the stock price is inversely related to the value of the option.
What can investors do to check that the returns of these strategies are not simply the compensation for taking more risk?
Adjust for risk using an asset pricing model such as the CAPM for Fama-French Factor model. If the returns are proportional to risk, the strategy will have an alpha=0.
Disadvantages of options
Relatively illiquid, high transactions costs. Difficult to accumulate large positions.
Top Flight Stock currently sells for $53. A one-year call option with strike price of $58 sells for $10, and the risk-free interest rate is 5.5%. What is the price of a one-year put with strike price of $58?
$11.97 P = 10 - 53 + 58/(1.055); P = 11.97
You purchase one IBM 200 call option for a premium of $6. Ignoring transaction costs, the break-even price of the position is
$206 +200 + $6 = $206
A preferred stock will pay a dividend of $3.50 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 11% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.
$31.82 3.50/.11 = 31.82.
Suppose that the average P/E multiple in the oil industry is 22. Exxon is expected to have an EPS of $1.50 in the coming year. The intrinsic value of Exxon stock should be
$33.00 =$22*1.50
You purchase one September 50 put contract for a put premium of $2. What is the maximum profit that you could gain from this strategy?
$4,800 -$200 + $5,000 = $4,800 (if the stock falls to zero).
A zero-coupon bond has a yield to maturity of 11% and a par value of $1,000. If the bond matures in 27 years, the bond should sell for a price of _______ today.
$59.74 $1,000/(1.11)^27 = $59.74.
Consider a one-year maturity call option and a one-year put option on the same stock, both with striking price $45. If the risk-free rate is 4%, the stock price is $48, and the put sells for $1.50, what should be the price of the call?
$6.23 C = 48 - [45/(1.04)] + 1.50; C = $6.23.
What is the price of 3-year zero-coupon bond with a par value of $1,000? 0f1=0% 1f1=7% 2f1=9% 3f1=10%
$857.41 $1,000/(1.00)(1.07)(1.09)
What should the purchase price of a 3-year zero-coupon bond be if it is purchased today and has face value of $1,000? 1-year forward rate of year 1: 4.6% 1-year forward rate of year 2: 4.9% 1-year forward rate of year 2: 5.2%
$866.32 $1,000/[(1.046)(1.049)(1.052)] = $866.32.
A coupon bond that pays interest annually has a par value of $1,000, matures in five years, and has a yield to maturity of 10%. The "intrinsic value" of the bond today will be ______ if the coupon rate is 7%.
$886.28 FV = 1,000, PMT = 70, n = 5, i = 10, PV = 886.28
A coupon bond that pays interest semi-annually has a par value of $1,000, matures in seven years, and has a yield to maturity of 11%. The intrinsic value of the bond today will be __________ if the coupon rate is 8.8%.
$894.51 FV = 1,000, PMT = 44, n = 14, i = 5.5, PV = 894.51
A put option on Facebook (European style, with strike price of X = $60 and expiration in T = 6 months) is traded at P0 = $5. Facebook's stock price is currently S0 = $56. Facebook pays no dividends. Assume that risk free rate is rf = 0% per year. You buy $1000 worth of this put option. What will be your dollar profit/loss if the stock price ends up at ST = $70 at expiration? What if instead the price is ST = $45?
-$1000 and $2000, respectively If ST = $70, the options expire out of the money and are worth zero, so you just lose the $1000 investment. If ST = $45, each contract is worth $60 - $45 = $15, and since you bought 200 contracts ($1000/5), you make $3000 from the options. Minus the $1000 investment, you get $2000.
A portfolio consists of 225 shares of stock and 300 calls on that stock. If the hedge ratio for the call is 0.4, what would be the dollar change in the value of the portfolio in response to a $1 decline in the stock price?
-$345 Calculation: -$225 + [-$300(0.4)] = -$345.
A portfolio consists of 400 shares of stock and 200 calls on that stock. If the hedge ratio for the call is 0.6, what would be the dollar change in the value of the portfolio in response to a $1 decline in the stock price?
-$520 -$400 + [-$200(0.6)] = -$520
Which of the following bonds has the longest duration?
-A 10-year maturity, 0% coupon bond. -The longer the maturity and the lower the coupon, the greater the duration.
Which of the following two bonds is more price sensitive to changes in interest rates? 1) A par value bond, X, with a 5-year-to-maturity and a 10% coupon rate. 2) A zero-coupon bond, Y, with a 5-year-to-maturity and a 10% yield to maturity.
-Bond Y because of the longer duration. -Duration is the best measure of bond price sensitivity; the longer the duration the higher the price sensitivity. Bond Y has a longer duration.
Portfolio A consists of 150 shares of stock and 300 calls on that stock. Portfolio B consists of 575 shares of stock. The call delta is 0.7. Which portfolio has a higher dollar exposure to a change in stock price?
-Portfolio B -300 calls (0.7) = 210 shares + 150 shares = 360 shares; 575 shares = 575 shares.
Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's
-coupon rate is lower. -The longer the maturity, the greater the interest-rate risk. The lower the coupon rate, the greater the interest-rate risk. The lower the yield to maturity, the greater the interest-rate risk. These concepts are reflected in the duration rules; duration is a measure of bond price sensitivity to interest rate changes (interest-rate risk).
If the stock price increases, the price of a put option on that stock __________ and that of a call option __________.
-decreases; increases -As stock prices increase, call options become more valuable (the owner can buy the stock at a bargain price). As stock prices increase, put options become less valuable (the owner can sell the stock at a price less than market price).
A $1 decrease in a call option s exercise price would result in a(n) __________ in the call option s value of __________ one dollar.
-increase; less than -Option prices are less than stock prices, thus changes in stock prices (market or exercise) are greater (in absolute terms) than are changes in prices of options.
The current market price of a share of CAT stock is $76. If a call option on this stock has a strike price of $76, the call
-is at the money. -If the striking price on a call option is equal to the market price, the option is at the money.
The current market price of a share of AT&T stock is $50. If a call option on this stock has a strike price of $45, the call
-is in the money and sells for a higher price than if the market price of AT&T stock is $40. -If the striking price on a call option is less than the market price, the option is in the money and sells for more than an out of the money option.
An inverted yield curve implies that
-long-term interest rates are lower than short-term interest rates. -The inverted, or downward sloping, yield curve is one in which short-term rates are higher than long-term rates. The inverted yield curve has been observed frequently, although not as frequently as the upward sloping, or normal, yield curve.
Consider a 5-year bond with a 10% coupon that has a present yield to maturity of 8%. If interest rates remain constant, one year from now the price of this bond will be
-lower This bond is a premium bond as interest rates have declined since the bond was issued. If interest rates remain constant, the price of a premium bond declines as the bond approaches maturity.
A European put option allows the holder to
-sell the underlying asset at the striking price on the expiration date -potentially benefit from a stock price increase and sell the underlying asset at the striking price on the expiration date.
A put option on a stock is said to be out of the money if
-the exercise price is less than the stock price. -An out of the money put option gives the owner the right to sell the shares for less than market price.
The maximum loss a buyer of a stock put option can suffer is equal to
-the put premium. -If an option expires worthless, all the buyer has lost is the price of the contract (premium).
All the inputs in the Black-Scholes option pricing model are directly observable except
-the variance of returns of the underlying asset return -The variance of the returns of the underlying asset is not directly observable, but must be estimated from historical data, from scenario analysis, or from the prices of other options.
The potential loss for a writer of a naked call option on a stock is
-unlimited -If the buyer of the option elects to exercise the option and buy the stock at the exercise price, the seller of the option must go into the open market and buy the stock (in order to sell the stock to the buyer of the contract) at the current market price. Theoretically, the market price of a stock is unlimited; thus the writer's potential loss is unlimited.
After academics discover and publish an anomaly, its profitability usually decreases substantially. What are the two reasons for why the profitability declines?
1. Data mining and/or regime shifts. The anomaly might be spurious or specific only to the academics' sample period. 2. Weak-form market efficiency. Now that the anomaly is part of the historical information set, traders will attempt to profit from it.
Briefly describe three theories explaining the shape of the term structure of interest rates.
1. Expectations Theory: Forward rates represent the markets expectation of future short term interest rates 2. Liquidity Preference Theory: Investors require additional compensation for longer-term investments 3. Market Segmentation Theory: Different investors supply capital for short- and long- term investments, so the term structure depends on different supply/demand equilibria
You have just purchased a 10-year zero-coupon bond with a yield to maturity of 10% and a par value of $1,000. What would your rate of return at the end of the year be if you sell the bond? Assume the yield to maturity on the bond is 11% at the time you sell.
1.4% $1,000/(1.10)^10 = $385.54; $1,000/(1.11)^9 = $390.92; ($390.92 - $385.54)/$385.54 = 1.4%.
An 8%, 15-year bond has a yield to maturity of 10% and duration of 8.05 years. If the market yield changes by 25 basis points, how much change will there be in the bond's price?
1.83% ΔP/P = (-8.05 × 0.0025)/1.1 = 1.83%.
A 10%, 30-year corporate bond was recently being priced to yield 12%. The Macaulay duration for the bond is 11.3 years. Given this information, the bond's modified duration would be
10.09. D* = D/(1 + y); D* = 11.3/(1.12) = 10.09.
A coupon bond that pays interest of $90 annually has a par value of $1,000, matures in nine years, and is selling today at a $66 discount from par value. The yield to maturity on this bond is
10.15% N=9 PV=1000-66 PMT=90 FV=1000 I=10.15%
A bond has a par value of $1,000, a time to maturity of 20 years, a coupon rate of 10% with interest paid annually, a current price of $850, and a yield to maturity of 12%. Intuitively and without using calculations, if interest payments are reinvested at 10%, the realized compound yield on this bond must be
10.9%. In order to earn yield to maturity, the coupons must be reinvested at the yield to maturity. However, as the bond is selling at discount, the yield must be higher than the coupon rate. Therefore, B is the only possible answer.
You purchased an annual interest coupon bond one year ago with six years remaining to maturity at the time of purchase. The coupon interest rate is 10% and par value is $1,000. At the time you purchased the bond, the yield to maturity was 8%. If you sold the bond after receiving the first interest payment and the bond's yield to maturity had changed to 7%, your annual total rate of return on holding the bond for that year would have been
11.95%. FV = 1000, PMT = 100, n = 6, i = 8, PV = 1092.46; FV = 1,000, PMT = 100, n = 5, i = 7, PV = 1,123.01; HPR = (1,123.01 - 1,092.46 + 100)/1,092.46 = 11.95%.
Bond C has a price of $711.78, 3 years until maturity. What is the yield to maturity?
12% ($1,000 - $711.78)/$711.78 = 0.404928; (1.404928)1/3 - 1.0 = 12%.
Bond D is $1,000 par value zero-coupon. 4 years til maturity, priced at $635.52
12% ($1,000 - $635.52)/$635.52 = 0.573515; (1.573515)1/4 - 1.0 = 12%.
Consider a one-year maturity call option and a one-year put option on the same stock, both with striking price $100. If the risk-free rate is 5%, the stock price is $103, and the put sells for $7.50, what should be the price of the call?
15.26 C = 103 - [100/(1.05)] + 7.50; C = $15.26.
The duration of a par value bond with a coupon rate of 7% and a remaining time to maturity of 3 years is
2.81 years.
A 7%, 14-year bond has a yield to maturity of 6% and duration of 7 years. If the market yield changes by 44 basis points, how much change will there be in the bond's price?
2.91% ΔP/P = (-7 × 0.0044)/1.06 = 2.91%
You have just purchased a 7-year zero-coupon bond with a yield to maturity of 11% and a par value of $1,000. What would your rate of return at the end of the year be if you sell the bond? Assume the yield to maturity on the bond is 9% at the time you sell.
23.8% $1,000/(1.11)7 = $481.66; $1,000/(1.09)6 = $596.27; ($596.27 - $481.66)/$481.66 = 23.8%
What is the yield to maturity of a 2-year bond? 1-year forward rate of year 1: 4.6% 1-year forward rate of year 2: 4.9%
4.7% [(1.046)(1.049)]^1/2 - 1 = 4.7%
Which one of the following is a correct statement concerning duration? 1. The higher the yield to maturity, the greater the duration. 2. The higher the coupon, the shorter the duration. 3. The difference in duration can be large between two bonds with different coupons each maturing in more than 15 years. 4. The duration is the same as term to maturity only in the case of zero-coupon bonds. 5. The higher the coupon, the shorter the duration; the difference in duration can be large between two bonds with different coupons each maturing in more than 15 years; and the duration is the same as term to maturity only in the case of zero-coupon bonds.
5 The relationship between ->duration and yield to maturity is an inverse one; as is the relationship between ->duration and coupon rate. The difference in the durations of longer-term bonds of varying coupons (high coupon vs. zero) is considerable. Duration equals term to maturity only with zeros.
The yield to maturity of a 20-year zero-coupon bond that is selling for $372.50 with a value at maturity of $1,000 is
5.1%. [$1,000/($372.50]^(1/20) - 1 = 5.1%
Consider a bond selling at par with modified duration of 22 years and convexity of 415. A 2% decrease in yield would cause the price to increase by 44%, according to the duration rule. What would be the percentage price change according to the duration-with-convexity rule?
52.3% ∆P/P = -D × ∆y + (1/2) × Convexity × (∆y)^2; = -22 × -.02 + (1/2) × 415× (.02)^2 = .44 + .083 = .523 52.3%
A put option on Facebook (European style, with strike price of X = $60 and expiration in T = 6 months) is traded at P0 = $5. Facebook's stock price is currently S0 = $56. Facebook pays no dividends. Assume that risk free rate is rf = 0% per year. If you purchase the put, at what stock price ST will you break even (have zero P&L)?
55
Holding other factors constant, which one of the following bonds has the smallest price volatility? 7-year, 0% coupon bond 7-year, 12% coupon bond 7 year, 14% coupon bond 7-year, 10% coupon bond
7 year, 14% coupon bond Duration (and thus price volatility) is lower when the coupon rates are higher.
You purchased a call option for $3.45 17 days ago. The call has a strike price of $45 and the stock is now trading for $51. If you exercise the call today, what will be your holding period return? If you do not exercise the call today and it expires, what will be your holding period return?
73.9%, -100% If the call is exercised the gross profit is $51 - 45 = $6. The net profit is $6 - 3.45 = $2.55. The holding period return is $2.55/$3.45 = .739 (73.9%). If the call is not exercised, there is no gross profit and the investor loses the full amount of the premium. The return is ($0 - 3.45)/$3.45 = -1.00 (-100%).
You purchased an annual interest coupon bond one year ago that had six years remaining to maturity at that time. The coupon interest rate was 10% and the par value was $1,000. At the time you purchased the bond, the yield to maturity was 8%. If you sold the bond after receiving the first interest payment and the yield to maturity continued to be 8%, your annual total rate of return on holding the bond for that year would have been
8% FV = 1,000, PMT = 100, n = 6, i = 8, PV = 1,092.46; FV = 1000, PMT = 100, n = 5, i = 8, PV = 1,079.85; HPR = (1,079.85 - 1,092.46 + 100)/1,092.46 = 8%.
Given the yield on a 3-year zero-coupon bond is 7% and forward rates of 6% in year 1 and 6.5% in year 2, what must be the forward rate in year 3?
8.5% f3 = (1.07)^3/[(1.06) (1.065)] - 1 = 8.5%
Given the yield on a 3 year zero-coupon bond is 7.2% and forward rates of 0f1 = 6.1% in year 1 and 1f1 = 6.9% in year 2, what must be the forward rate 2f1 in year 3?
8.6% f3 = (1.072)^3/[(1.061) (1.069)] - 1 = 8.6%
A coupon bond that pays interest semi-annually is selling at par value of $1,000, matures in seven years and has a coupon rate of 8.6%. The yield to maturity on this bond is
8.6%. When a bond sells at par value, the coupon rate is equal to the yield to maturity.
You buy one Home Depot June 60 call contract and one June 60 put contract. The call premium is $5 and the put premium is $3. Your maximum loss from this position could be
800 -$5 + (-$3) = -$8 × 100 = $800
A coupon bond that pays interest annually is selling at par value of $1,000, matures in five years, and has a coupon rate of 9%. The yield to maturity on this bond is
9% -When a bond sells at par value, the coupon rate is equal to the yield to maturity.
A coupon bond that pays interest of $40 semi-annually has a par value of $1,000, matures in four years, and is selling today at a $36 discount from par value. The yield to maturity on this bond is
9.09%. FV = 1,000, PMT = 40, n = 8, PV = -964, i = 9.09%.
Which of the following bonds has the longest duration? A 12-year maturity, 0% coupon bond. A 12-year maturity, 8% coupon bond. A 4-year maturity, 8% coupon bond. A 4-year maturity, 0% coupon bond.
A 12-year maturity, 0% coupon bond. The longer the maturity and the lower the coupon, the greater the duration.
Which of the following two bonds is more price sensitive to changes in interest rates? 1) A par value bond, D, with a 2-year-to-maturity and a 8% coupon rate. 2) A zero-coupon bond, E, with a 2-year-to-maturity and a 8% yield to maturity.
Bond E because of the longer duration. Duration is the best measure of bond price sensitivity; the longer the duration the higher the price sensitivity.
long straddle
Buying both a put and a call, each with the same expiration date and exercise price, is a long straddle.
Describe covered call and straddle option strategies (i.e., which positions compose each portfolio).
Covered call: Buy one unit of stock, sell one unit of call (with X > S) Straddle: Buy one unit of call, buy one unit of put of equal strike
Explain the difference between cash settlement and physical settlement.
For example, consider a future on head of cattle. If it calls for cash settlement, money is simple transferred between parties at expiration. If it calls for physical settlement, the seller literally has to deliver cows to the buyer at the specified location.
If interest rates do not change, a year from now, the duration of portfolio P will increase/stay the same/decrease?
Holding all else equal, duration decreases as time to maturity decreases.
Which one of the following variables influence the value of put options? I) Level of interest rates II) Time to expiration of the option III) Dividend yield of underlying stock IV) Stock price volatility
I, II, III, and IV
The Black-Scholes formula assumes that I) the risk-free interest rate is constant over the life of the option. II) the stock price volatility is constant over the life of the option. III) the expected rate of return on the stock is constant over the life of the option. IV) there will be no sudden extreme jumps in stock prices.
I, II, IV
Portfolio A consists of 600 shares of stock and 300 calls on that stock. Portfolio B consists of 685 shares of stock. The call delta is 0.3. Which portfolio has a higher dollar exposure to a change in stock price?
Portfolio A 300 calls (0.3) = 90 shares + 600 shares = 690 shares; 685 shares = 685 shares.
Advantages of options
Relatively cheap way to gain exposure due to the embedded leverage. Able to customize your desired payoff structure. Can be a good tool for hedging.
Consider a 10-year bond with a 10% coupon that has a present yield to maturity of 12%. If interest rates remain constant, one year from now the price of this bond will be higher/the same/lower/cannot tell?
Since the coupon rate is below the yield, this bond must be selling at a discount. As time progresses, the value of the bond will increase as time passes (holding all else constant).
A bond has a time to maturity of 20 years, an annual coupon rate of 10% and a yield to maturity of 12%. Intuitively and without using calculations, if interest payments are reinvested at 10% and the bond is held until maturity, then annualized holding period return on this bond must be (below/equal/above) 12%?
Since the reinvestment rate is lower than the yield to maturity, the annualized HPR must be below the yield to maturity
According to the expectations hypothesis of term structure, interest rates are expected to decrease/stay the same/increase?
Since this term structure of interest rates is upward sloping, EH suggests that investors anticipate short-term rates to increase in the future.
post-earnings announcement drift
Stock prices tend to underreact to "surprise" earnings announcements: the firm's stock tend to outperform (underperform in the weeks following a positive (negative) earnings surprise.
Momentum
Stocks that outperformed (underperformed) relative to the market over the past six months often continue to outperform (underperform) relative to the market over the next six months.
Why do option market-makers have to adjust their delta-hedges every day even if their option portfolio does not change?
The price and volatility of the underlying can change, requiring rebalancing. Additionally, time to maturity decreases as time passes.
Other things equal, the price of a stock call option is positively correlated with which of the following factors?
The stock price, time to expiration, and stock volatility The exercise price is negatively correlated with the call option price.
Portfolio A consists of 500 shares of stock and 500 calls on that stock. Portfolio B consists of 800 shares of stock. The call delta is 0.6. Which portfolio has a higher dollar exposure to a change in stock price?
The two portfolios have the same exposure. 500 calls (0.6) = 300 shares + 500 shares = 800 shares; 800 shares = 800 shares.
The weak form of the efficient market hypothesis contradicts
The weak form of the efficient market hypothesis contradicts technical analysis, but is silent on the possibility of successful fundamental analysis.
Why are they called "anomalies"?
These strategies produce returns that are not proportional to risk as measured by traditional asset pricing models such as the CAPM for Fama-French 3 Factor model. These abnormal returns seem to violate EMH.
SELL AT PAR VALUE
YTM=COUPON
A hedge ratio for a put is always
between minus one and zero.
You buy one Home Depot June 60 call contract and one June 60 put contract. The call premium is $5 and the put premium is $3. At expiration, you break even if the stock price is equal to
both $52 and $68. Call: -$60 + (-$5) + $3 = $68 (break even); Put: -$3 + $60 + (-$5) = $52 (break even); thus, if price increases above $68 or decreases below $52, a profit is realized.
The duration of a coupon bond
changes as interest rates and time to maturity change, can only predict price changes accurately for small interest rate changes, and increases as the yield to maturity decreases.
Forward rates ____________ future short rates because ____________.
differ from; they are imperfect forecasts Forward rates are the estimates of future short rates extracted from yields to maturity but they are not perfect forecasts because the future cannot be predicted with certainty; therefore they will usually differ.
The duration of a 20-year zero-coupon bond is
equal to 20. Duration of a zero-coupon bond equals the bond's maturity.
If the stock price decreases, the price of a put option on that stock __________ and that of a call option __________.
increases; decreases
Nicholas Manufacturing just announced yesterday that its fourth quarter earnings will be 10% higher than last year's fourth quarter. Nicholas had an abnormal return of -1.2% yesterday. This suggests that
investors expected the earnings increase to be larger than what was actually announced. Anticipated earnings changes are impounded into a security's price as soon as expectations are formed. Therefore a negative market response indicates that the earnings surprise was negative, that is, the increase was less than anticipated.
The current market price of a share of Disney stock is $60. If a call option on this stock has a strike price of $65, the call
is out of the money.
Immunization is not a strictly passive strategy because
it requires frequent rebalancing as maturities and interest rates change. As time passes the durations of assets and liabilities fall at different rates, requiring portfolio rebalancing. Further, every change in interest rates creates changes in the durations of portfolio assets and liabilities.
A hedge ratio of 0.70 implies that a hedged portfolio should consist of
long 0.70 shares for each short call. The hedge ratio is the slope of the option value as a function of the stock value. A slope of 0.70 means that as the stock increases in value by $1, the option increases by approximately $0.70. Thus, for every call written, 0.70 shares of stock would be needed to hedge the investor's portfolio.
You buy one Home Depot June 60 call contract and one June 60 put contract. The call premium is $5 and the put premium is $3. Your strategy is called
long straddle Buying both a put and a call, each with the same expiration date and exercise price, is a long straddle.
To the option holder, put options are worth ______ when the exercise price is higher; call options are worth ______ when the exercise price is higher.
more; less The holder of the put would prefer to sell the asset to the writer at a higher exercise price. The holder of the call would prefer to buy the asset from the writer at a lower exercise price.
Ceteris paribus, the price and yield on a bond are
negatively related. Bond prices and yields are inversely related.
A hedge ratio for a call option is ________ and a hedge ratio for a put option is ______.
positive; negative Call option hedge ratios must be positive and less than 1.0, and put option ratios must be negative, with a smaller absolute value than 1.0.
If you believe in the ________ form of the EMH, you believe that stock prices reflect all relevant information including historical stock prices and current public information about the firm, but not information that is available only to insiders.
semi-strong If you believe in the ________ form of the EMH, you believe that stock prices reflect all relevant information including historical stock prices and current public information about the firm, but not information that is available only to insiders.
List major types of derivatives besides options (no need to describe them)
swaps and futures
An inverted yield curve is one
that slopes downward. An inverted yield curve occurs when short-term rates are higher than long-term rates.
Delta is defined as
the change in the value of an option for a dollar change in the price of the underlying asset. An option's hedge ratio (delta) is the change in the price of an option for a $1 increase in the stock price.
The main difference between the three forms of market efficiency is that
the definition of information differs. The main difference is that weak form encompasses only historical data, semistrong form encompasses historical data and current public information, and strong form encompasses historical data, current public information, and inside information. All of the other definitions remain the same.
Other things equal, the price of a stock call option is positively correlated with the following factors except
the exercise price/strike price. The exercise price is negatively correlated with the call option price.
All of the following factors affect the price of a stock option
the expected rate of return on the stock. The risk-free rate, riskiness of the stock, and time to expiration are directly related to the price of the option; the expected rate of return on the stock does not affect the price of the option.
The value of a stock put option is positively related to the following factors except
the stock price. The time to expiration and striking price are positively related to the value of a put option; the stock price is inversely related to the value of the option.
In an efficient market the correlation coefficient between stock returns for two nonoverlapping time periods should be
zero In an efficient market there should be no serial correlation between returns from nonoverlapping periods.
Suppose you purchase one WFM May 100 call contract at $5 and write one WFM May 105 call contract at $2. If, at expiration, the price of a share of WFM stock is $103, your profit would be
zero. $103 - $100 = $3 - ($5 - $2) = 0; $0 × 100 = $0
