A stock currently sells for $69. The annual growth rate of the stock is 15%, and the stock’s annual volatility is 35%. The risk-free rate is currently 5%. You have bought a six-month European put option on this stock with an exercise price of $70.
a. Use @RISK to value this option.
b. Use @RISK to analyze the distribution of percentage returns (for a six-month horizon) for the following portfolios:
¦ Portfolio 1: Own 100 shares of the stock.
¦ Portfolio 2: Own 100 shares of the stock and buy the put described in part a.
Which portfolio has the larger expected return? Explain why portfolio 2 is known as portfolio insurance.
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