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Option Pricing -- Risk-free Portfolio
Although replicating portfolio and risk neutral approach provide elegant solutions to option pricing, they require strong assumptions which are not realistic. In real business world, people rely on risk-free portfolio approach to valuation options. By creating risk-portfolio including the options to be priced, risk-free rate can be applied confidently.
Suppose you want to price a call option on WWW Inc. The current stock price of WWW is $60. The risk-free rate is 3%. What is the appropriate price of the 1 year call option of WWW Inc. with a strike price of $58 using risk-free portfolio approach? You project the stock price of WWW will either be $54 or $64 in a year.
(Cost of debt) The Walgreen Corporation is contemplating a new investment that it plans to finance using one-third debt. The firm can sell new $1,000 par value bonds with a 15-year maturity at a price of $948 that carries a coupon interest rate of 12..
Kimco's cost of capital is 10 percent and the tax rate is 40 percent. On the basis of NPV, should management install the network system?
PK Software has 9.1 percent coupon bonds on the market with 22 years to maturity. The bonds make semiannual payments and currently sell for 112 percent of par. What is the current yield on PK's bonds? What is the YTM? What is the effective annual yie..
Quantitative Problem: Barton Industries can issue perpetual preferred stock at a price of $48 per share. The stock would pay a constant annual dividend of $4.30 per share. If the firm's marginal tax rate is 40%, what is the company's cost of preferre..
You have $20,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 14 percent and Stock Y with an expected return of 11 percent. Assume your goal is to create a portfolio with an expected return of 12.55 percent. How..
A stock has had returns of 11 percent, -8 percent, 6 percent, 21 percent, 24 percent, and 16 percent over the last six years. What is the arithmetic return? What is the geometric return for this stock? What is the standard deviation? (use the arithme..
What is the approximate annual interest rate compounded annually if your money will double in 8 years if it is put in a savings account? Assume you borrow $25,000 at 8% per year interest compounded annually. You pay nothing until the end of 10 years ..
Discuss the risks to both the plan sponsor and plan beneciaries under the four types of pension plans.
Year-to-date, Oracle had earned a −1.52 percent return. During the same time period, Valero Energy earned 8.04 percent and McDonald's earned 0.68 percent. If you have a portfolio made up of 20 percent Oracle, 25 percent Valero Energy, and 55 percent ..
The firm’s accounts payable were $375,000. Sales in 2013 were $2,500,000, and are expected to increase by 40% in 2014. Recall that current liabilities vary directly with sales. How much in total debt is the firm expecting for the year 2014? Calculate..
How can you find the weights to be used for the WACC and which are more appropriate (market versus book)? What does WACC stand for and why is it important when dealing with the Cost of Capital?
The Shell Corporation has a 34% tax rate and owns a piece of petroleum-drilling equipment that costs $138,600 and will be depreciated at a CCA rate of 30%. Calculate the overall present worth of these cash flows with tax effects if market interest r..
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