Question

1) You have three European 3-Month XYZ calls with exercise prices 100, 120 and 130. The calls are at $8,5 and 3, respectively. Do wou see any arbitrage opportunity? Justify your answer. 2) You have XYZ trading at $42. European 6-month 40 calls and puts are traded at: call put bid/ask 5 / 5.5 2.75 / 3.25 Assuming the risk free rate is 0%, do you see any arbitrage opportunity? Justify your answer. 3) Create a portfolio with the following payoffs: 2 St if St < 20 60-Stif 20s St < 40 St-20 if 40s St 4) The value of a firm is 150 that can go up or down by 20% per period for two periods. The risk free rate is 3% per period. There is zero-coupon debt maturing at the end of the second period. The face value of the debt is 100. What is the WACC of the firm if the cost of equity is 16% and the tax rate is 30%? 5) Show that options are riskier than the underlying assets.

Please answer part 4 and 5. Please do it asap.Thank you very much

Answer 1

4) cost of debt can't be calculated because PV of deb is not given.

hence the question is not solvable.

5) Options are purchased by paying certain amount of premium at the beginning.

if the chances of up move or down move are not in our favor, we might end having loss more than we thought of.

For example, you have stock price of 50 and you are hoping that it will rise in near future.

so you have purchased a call option @ 10.

but in the future instead of rising it falls to 48

therefore you made a loss of 12 (10+2).

if you have not entered into an option then you loss would have been only 2 instead of 12.

so entering into an options are fully based on personal believe which can/cannot be fulfilled.

Therefore options are more riskier than the underlying assets.