a) A call option matures in 6 months. The underlying stock price is $50 and the standard deviation of stock’s return is 14 percent per year. The risk-free rate is 5 % per annum. The exercise price is $60. What is the price of the call option?
b) What is a protective put strategy? How can it be duplicated? In light of your answer, explain the put-call parity condition.
c) You are a financial manager and you have bonds worth $3,000,000 in your portfolio which have a 7 percent coupon rate and will be maturing in 10 years from now. What type of risk exposure do you face on these bonds? Suppose a futures contract on these bonds is available with a standard contract size of US$300,000 per contract. How will you hedge your exposure? If the market interest rates change to 9 percent, what will be your position?
d) Explain why diversification per se is probably not a good idea for merger.