FIN 380 Exam 2

Fred has just sold short 3 contracts of May wheat on the CBT. These are 5,000 bushel contracts. The initial deposit is $1,500 per contract with a maintenance margin of $1,200. (a) What is Fred's total initial margin? (b) How much of an increase in the price of wheat is necessary to cause a margin call?

(a) (3)($1,500) = $4,500 (b) ($1,500 - $1,200)/5,000 = $0.06 The value of a contract can rise by $300 before a margin call. On a 5,000 contract $300 is equivalent to a six-cent increase per bushel.

9. Amy owns 100 shares of ABC stock with a cost basis of $35 a share. The stock is currently trading at $54 a share. Amy believes the price of ABC stock will fall to $45 a share in the near future but over the longer term of 3 to 5 years, increase in value to $75 a share. Amy would like to benefit from the expected near-term decline if it occurs. Therefore, Amy writes a covered call at a strike price of $55 and a premium of $2. (a) How will the covered call help Amy profit if the expected price decline occurs? (b) What is the best-case scenario for? (c) What is the maximum profit Amy can incur from the call itself (ignoring the stock)?

(a) If the stock declines to $45 a share, the call will not be exercised and Amy can keep the option premium of $200. Her total profit is $1200 [($45 - $35)100 + ($2)100]. (b) If the call is exercised, Amy would have to sell her shares at the $55 strike price and lose any additional potential gain she could have realized by selling at a higher price. Her total profit is $2200 {($55 - $35)100 + ($2)100]. (c) The maximum profit is the option premium amount of $200.

Grant purchased one call on XYZ stock at an exercise price of $25. The market price of XYZ stock when Grant purchased the call was $24 a share. XYZ is currently priced at $30 a share. Grant paid $120 to buy the call. How much profit will Grant make if he exercises the option today and then sells the shares? Ignore all transaction-related costs. A) $380 B) $480 C) $500 D) $600

A

The stock of a technology company has an expected return of 15% and a standard deviation of 20%. The stock of a pharmaceutical company has an expected return of 13% and a standard deviation of 18%. A portfolio consisting of 50% invested in each stock will have an expected return of 14 % and a standard deviation A) less than the average of 20% and 18%. B) the average of 20% and 18%. C) greater than the average of 20% and 18%. D) the answer cannot be determined with the information given.

A

Which of the following features are shared by futures contracts and options? I. They have specified expiration dates. II. Their value is derived from changes in the value of some other asset. III. Unprofitable futures or options can simply be allowed expire unexercised. IV. Futures contracts specify the price at which the commodity will be delivered at the expiration date. A) I and II only B) I and IV only C) II and III only D) I, II and III only

A

Calculate the return on invested capital on a platinum futures contract for 50 troy ounces when the purchase price is $810.40 per ounce and the sale price is $823.54 per ounce. The initial deposit is $2,500.

Answer: Return = {($823.54)(50) - ($810.40)(50)}/$2,500 = 26.28%

Eric has just purchased a heating oil contract at $2.05 per gallon. The contract size is 21,000 gallons. Initial margin is $6,075; maintenance margin is $4,500. If the price of heating oil is $2.15 when the contract expires, Eric's profit or loss is A) $(2,100) loss. B) $2,100 profit. C) $(3,975) loss. D) $(2,400) loss.

B

NZMA stock is currently selling for $128. Which of the following options is "in-the-money"? A) March 130 call B) February 125 call C) March 125 put D) February 100 put

B

One reason that writing options can be a viable and profitable investment strategy is that A) the option writer collects the quarterly dividends. B) most options expire unexercised. C) an option writer determines when the option is exercised. D) an option writer can exercise the option to avoid a potential loss.

B

The buyer of a listed American option has which of the following rights? I. the right to change the expiration date II. the right to change the strike price III. the right to resell the option IV. the right to let the option expire unexercised A) I and III only B) III and IV only C) I, III and IV only D) II, III and IV only

B

The stock of ABC, Inc. has a beta of .80. The market rate of return is expected to increase by 5%. Beta predicts that ABC stock should A) increase in value by 6.25%. B) increase in value by 4.0%. C) decrease in value by 1.0%. D) increase in value by .8%.

B

What is the time value of a put with a strike price of $30 when the option price is $500 and the underlying common stock sells for $27? A) $100 B) $200 C) $300 D) $400

B

A stock's beta value is a measure of A) interest rate risk. B) total risk. C) systematic risk. D) diversifiable risk.

C

Estimates of a stock's beta may vary depending on I. when the estimate was made. II. the risk-free rate of interest used. III. how many months of returns were used to estimate the beta. IV. the index used to represent market returns. A) I, II and IV only B) II and IV only C) I, III and IV only D) I, II and III only

C

Lew paid $300 to purchase a call on Delta stock with a strike price of $25. What does the market price of Delta have to be for Lew to break-even on his option investment? Ignore transaction costs and taxes. A) $22 B) $25 C) $28 D) cannot be determined from the information provided

C

Logan sold a corn futures contract using the initial margin of $2,700. His maintenance margin is $2,000. The price of began to rise in early summer, but Logan wants to keep his contract. When his margin falls below $2,000 (minimum maintenance) A) his contract will be automatically sold or canceled. B) he does not need to do anything since the most he can lose is $2,700. C) he will need to deposit at least $700 with his broker to bring his margin back up to the initial deposit. D) he will need to deliver the corn immediately.

C

Which of the following statements concerning beta are correct? I. Stock with high standard deviations of returns will always high betas. II. The higher the beta, the higher the expected return. III. A beta can be positive, negative, or equal to zero. IV. A beta of .35 indicates a lower rate of risk than a beta of -0.50. A) II and III only B) I and IV only C) II, III and IV only D) I, II, III and IV

C

8. Alan just bought 100 shares of Global, Inc. (GLO) at $45 per share and as protection he also bought a three-month put with a $45 strike price at a cost of $400. One of two scenarios is expected to occur in the next three months: (a) GLO stock declines to $33; and (b) GLO stock rises to $61. Calculate the profit or loss under each scenario and explain how the hedge has provided protection for Alan's position in GLO. Ignore transaction costs.

Cost of GLO = ($45)(100) = $4,500 Cost of put = $400 In three months: (a) GLO at $33 Total loss = {($45 - $45)(100)} - $400 = $-400 (b) GLO at $61 Total gain = {($61 - $45)(100)} - $400 = $1,200 At a cost of $400, Alan minimized his loss under scenario (a) to $400, which is less than the $1,200 he would have lost holding GLO stock only. For this downside protection, Alan gave up $400 and reduced his profit in scenario (2) to $1,200 rather than the $1,600 he would have earned by holding only the GLO stock. The hedge reduced his risk by lowering his potential return.

Beta is the slope of the best fit line for the points with coordinates representing the ________ and the ________ for each one of several years. A) rate of return; level of risk for an individual security B) rate of inflation; rate of return for an individual security C) risk level of a stock; market rate of return D) market rate of return; security's rate of return

D

Fred bought 600 shares of Edgewood stock at a price of $19. The stock is currently selling for $53 a share. To protect his profits, Fred should buy A) 600 call options with a strike price of $55. B) 600 put options with a strike price of $50. C) 6 call options with a strike price of $55. D) 6 put options with a strike price of $50.

D

Two assets have a coefficient of correlation of -.4. A) Combining these assets will increase risk. B) Combining these assets will have no effect on risk. C) Combining these assets may either raise or lower risk. D) Combining these assets will reduce risk.

D

What is the expected return on a stock with a beta of 1.09, a market risk premium of 8%, and a risk-free rate of 4%? A) 4.36% B) 8.36% C) 8.72% D) 12.72%

D

1. Returns on the stock of First Boston and Midas Metals for the years 2010-2013 are shown below. First Boston Midas Metals Portfolio 2010 -18.00% 26.00% 2011 32.00% -5.00% 2012 18.00% 3.00% 2013 1.00% 10.00% a. Compute the average annual return for each stock and a portfolio consisting of 50% First Boston and 50% Midas. b. Compute the standard deviation for each stock and the portfolio. c. Are the stocks positively or negatively correlated and what is the effect on risk?

First Boston Midas Metals Portfolio 2010 -18.00% 26.00% 4.00% 2011 32.00% -5.00% 13.50% 2012 18.00% 3.00% 10.50% 2013 1.00% 10.00% 5.50% a. Avg. 8.25% 8.50% 8.38% b. St. Dev. 21.61% 13.18% 4.40% c. The two stocks are negatively correlated. The return on the 50/50 portfolio is half way between the returns for each stock, but the standard deviation is much lower than for either stock, indicating that the portfolio has much less risk than the individual stocks.