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This question asks you to apply your knowledge on option securities.

(a) Suppose the price of a stock today is $40 and it evolves according to u = 1.1 and d = 0.9 in 6-month periods. A call option on the stock expires after 1 year and has exercise price $42. Find the prices and the payoffs of the stock and call respectively for each possible scenario.

(b) Use the Binomial Model to finnd the price of this call if the 6 month risk free interest rate is 2 percent.

(d) Now suppose that the price of the stock after 1 year can take any positive value. A collar is a portfolio consisting of a stock, buying a put on the stock and writing a call on the stock. The put exercise price is $42 and the call exercise price is $44. Prices of the call and put are what you found in (b) and (c). Write the payoff of the collar as a piece-wise function.

(e) Write the profit of the collar described above as a piece-wise function.

(f) Draw the payoff of the collar described above as a function of S1.

(g) Draw the profit of the collar described above as a function of S1.

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Financial Management, Finance

Category:- Financial Management
Reference No.:- M92781515

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