Problem 1: In the Capital Asset Pricing Model (CAPM) the expected return of a security should be a function and only a function of what type of risk? Explain why other forms of risk are not important.
Problem 2: According to the Black-Scholes option pricing model, what factors are important for pricing options?
a) IBM's stock price is at $100 per share. A June 100 call option (exercise price 100) is trading for $3 a share. What is the intrinsic value and what is the time premium? Explain why it has a positive price?
b) If on May 1, 2009, three call options on Richmond Associates stock, all expiring in December 2009, sold for the following prices:
Exercise Price Option Premium
$50 $7.50
$60 $3.00
$70 $1.50
You buy one call with $50 exercise price, sell (write) two calls with $60 exercise price, buy one call with $70 exercise price.
What is your net profit (loss) if Richmond Associates' stock price is $54 at expiration?