Compare among expected monetary approach expected utility

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Reference no: EM1316247

Comparisons between expected monetary approach and expected utility approach

A broker at Merrill Lynch is convinced that the price of ING's stock will rise in the next six months. ING is currently trading at $57/share. Upon inspecting the latest quotes on the options market, the broker discovers that she can purchase an option of ING for $5/share allowing her to buy ING at $55/share in two months. She could also purchase an option to buy ING within a six month period; this option, which has a cost of $10/Share, also has an exercise price of $55/share. She has estimated the following probability distributions for the stock price on the days the options expire:

Price	$50	$55	$60	$65	$70	$75
Probability at 2 months	0.05	0.15	015	0.25	0.35	0.05
Probability at 6 months	0	005	005	0.20	0.30	0.40

The broker plans to exercise her option just before its expiration if ING is selling for more than $55/share an immediately sell it at that market price. Of course, if ING is selling for less than $55/share on the expiration date then she will lose the entire purchase cost of the option. Before weighing her option she consults the latest update from the Risk

Management department:

Profit	$1,500	$1,000	$500	0	($750)	($2,000)
Utility	1.0	0.9	0.9	0.7	01	0.0

She needs to decide to purchase a 2 month option on 100 shares, a 6 month option on 100 shares, or do nothing at all

Sketch the broker's utility curve and describe what it says about her risk profile?

Reference no: EM1316247

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