Discussion Post
I. You are evaluating a stock that is currently selling for $45 per share. Over the investment period, you think that the stock price might go down 15% or go up 15%. There is a call option available on the stock with an exercise price of $50. Answer the following questions about hedging your position in the stock. Assume that you will hold one share, and the risk-free rate is 5%.
• What is the hedge ratio? How much would you borrow to purchase the stock? What is the amount of your net investment in the stock?
• Complete the table below to show the value of your stock portfolio at the end of the holding period.
o Scenario Low Stock Price High Stock Price
o Value of Stock at Year End
o Repayment of Loan
o Value of Call Position
o Total
• How many call options will you combine with the stock to construct the perfect hedge? Will you buy the calls or sell the calls?
• What must the price of one call option be? And put option?
II. Use the Black-Scholes to find the value of a call option on the following stock.
Time to expiration 2-month
Standard deviation 30% per year
Exercise price $40
Stock price $45
Interest rate 4%
• What is the value of the put option with the same strike price?
The response should include a reference list. Double-space, using Times New Roman 12 pnt font, one-inch margins, and APA style of writing and citations.