Reference no: EM133065209

Question 1: 'The unsystematic risk of a share is irrelevant in valuing the share since it can be diversified away. It is also irrelevant for valuing a call option on the share.' True or false? Explain your answer

Question 2: Understanding option quotes
Use the following option quote to answer the questions below.
15 Dec 20xx
Little Co
Last sale price $12.00

Strike price             Jan                      Feb                  Mar                    Jan                   Feb      Mar

$9.60                     $1.80                 $2.42                 $2.50                80 cents             $1.10   $1.60

a Is the January call options in the money? What is the intnnsic value of a Little Co call option?
b One of the options is clearly mispnced. Which one? At a minimum, what should it sell for? Explain how you could profit from the mispncing.
c This is a little harder: what is the most the mispriced option should sell for? Explain.

Question 3: Arbitrage and options
You notice that shares in the Town Corp Ltd are going for $7.55 per share. Call options with an exercise price of $6.25 per share have a premium of $0.95. What is wrong here?

Question 4: Basic properties of options
What is a call option? A put option? Under what circumstances might you want to buy each? Which one has greater potential profit?

Question 5:
The Samon Company's assets are currently worth $850 million. In a year, they will be worth $700 million or $1100 million. The risk-free rate is 5 per cent. Suppose that Samon has an outstanding debt issue due in one year, with a face value of $600 million.
What is the value of the equity?
What is the value of the debt? The interest rate on the debt if it is totally secured by the company's assets?
Would the value of the equity go up or down if the risk-free rate were 20 per cent? Why? What does your answer illustrate?

Question 6: Using the pricing equation
A one-year call contract on TeePee Co Ltd shares sells for $1000. In one year, the shares will be worth $2 or $4 per share. The exercise price on the call option is $3. What is the current value of the share if the risk-free rate is 4 per cent?

Question 7: Calls versus puts
Shares in the Paddles Co Ltd currently sell for $10 per share. if a put option and a call option are available with $10 exercise prices, which do you think will sell for more, the put or the call? Explain.

Question 8:  If the risk of a share increases, what is likely to happen to the price of call options on the share? To the price of put options? Why?

Question 9: Equity as an option
The Lone Company Ltd has a debt issue with a face value of $500 that is coming due in one year. The value of Lone's assets is currently $650. RU Where, the CEO, believes that the assets in the firm will be worth $400 or $900 in a year. The going rate on one-year government securities is 8 per cent.
What is the value of the equity? The value of the debt?