Show that the ex-dividend value of hema equity is consistent

Reference no: EM13500582

1.The current price of Estelle Corporation stock is $25. In each of the next two years, this stock price will either go up by 20% or go down by 20%. The stock pays no dividends. The one-year risk-free interest rate is 6% and will remain constant. Using the Binomial Model, calculate the price of a one-year call option on Estelle stock with a strike price of $25.

2.Using the information in Problem 1, use the Binomial Model to calculate the price of a one year put option on Estelle stock with a strike price of $25.

3.The current price of Natasha Corporation stock is $6. In each of the next two years, this stock price can either go up by $2.50 or go down by $2. The stock pays no dividends. The one-year risk-free interest rate is 3% and will remain constant. Using the Binomial Model, calculate the price of a two-year call option on Natasha stock with a strike price of $7.

4.Using the information in Problem 3, use the Binomial Model to calculate the price of a two-year European put option on Natasha stock with a strike price of $7.

5.Suppose the option in Example 21.1 actually sold in the market for $8. Describe a trading strategy that yields arbitrage profits.

6.Suppose the option in Example 21.2 actually sold today for $5. You do not know what the option will trade for next period. Describe a trading strategy that will yield arbitrage profits.

7.Eagletron’s current stock price is $10. Suppose that over the current year, the stock price will either increase by 100% or decrease by 50%. Also, the risk-free rate is 25% (EAR).

a. What is the value today of a one-year at-the-money European put option on Eagletron stock?

b. What is the value today of a one-year European put option on Eagletron stock with a strike price of $20?

c. Suppose the put options in parts (a) and (b) could either be exercised immediately, or in one year. What would their values be in this case?

8.What is the highest possible value for the delta of a call option? What is the lowest possible value? (Hint: See Figure 21.1.)

9.Hema Corp. is an all equity firm with a current market value of $1000 million (i.e., $1 billion),and will be worth $900 million or $1400 million in one year. The risk-free interest rate is 5%. Suppose Hema Corp. issues zero-coupon, one-year debt with a face value of $1050 million, and uses the proceeds to pay a special dividend to shareholders. Assuming perfect capital markets,use the binomial model to answer the following:

a. What are the payoffs of the firm’s debt in one year?

b. What is the value today of the debt today?

c. What is the yield on the debt?

d. Using Modigliani-Miller, what is the value of Hema’s equity before the dividend is paid? What is the value of equity just after the dividend is paid?

e. Show that the ex-dividend value of Hema’s equity is consistent with the binomial model. What is the Δ of the equity, when viewed as a call option on the firm’s assets?

10.Consider the setting of Problem 9. Suppose that in the event Hema Corp. defaults, $90 million of its value will be lost to bankruptcy costs. Assume there are no other market imperfections.

a. What is the present value of these bankruptcy costs, and what is their delta with respect to the firm’s assets?

b. In this case, what is the value and yield of Hema’s debt?

c. In this case, what is the value of Hema’s equity before the dividend is paid? What is the value of equity just after the dividend is paid?

Reference no: EM13500582

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