Reference no: EM132566369
One of your Aunts owns a small store (called "Best Gift Ideas") that sells gift items and is located in a Mall whose Anchor tenant is "The Best Foods", a large grocery store, which does not sell any gift items. The Best Foods is the main source of traffic to the Mall. The gift store is located next to The Best Foods. If The Best Foods closes, the gift store is expected to lose 90 percent of its clients. The uncertainty is bothering your Aunt.
In a recent festive gathering, your Aunt found out that you are studying Business at Monash University Malaysia. She asked you for a professional advice in managing or even eliminating this risk. She told you that she needs to recover approximately 6 months' worth of earnings. She can find another location within this time.
This means she needs total of $30,000.
You are given the following information:
The Best Foods is a main board listed company and has options trading on its common stock. The current stock price of The Best Foods is $10 per share and its annual return volatility is 25 percent. The effective annual risk-free rate is 2 percent per annum. There are two put options on The Best Foods stock with exercise price of $11 and $9. Both options has one year to expiration.
- Find the intrinsic values of the put options
- Find the value of the two put options using the Binomial Option Pricing Model. Also, compute their respective time values.
- Find the value of a 1 year call option with strike price equal to $10. Also, compute the intrinsic value and time value for this option.
- If you want to advise your Aunt to use put option with exercise price of $9 for the insurance purpose. How many put options does your Aunt need to buy to generate $30,000 if The Best Foods defaults? How much will be the cost of this insurance to the Best Gift Ideas? Assume that the option value you computed in part (b) is the market price of the put option with exercise price of $9.
-What is the duration of the insurance (how long is it going to last)?