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Imagine that you are holding 5,000 shares of stock, currently selling at $40 per share. You are ready to sell the shares but would prefer to put off the sale until next year for tax reasons. If you continue to hold the shares until January, however, you face the risk that the stock will drop in value before year-end. You decide to use a collar to limit downside risk without laying out a good deal of additional funds. January call options with a strike price of $45 are selling at $2, and January put options with a strike price of $35 are selling at $3. Assume that you hedge the entire 5,000 shares of stock.
a. What will be the value of your portfolio in January (net of the proceeds from the options) if the stock price ends up at $30. (Omit the "$" sign in your response.)
Stock price $
b. What will be the value of your portfolio in January (net of the proceeds from the options) if the stock price ends up at $40? (Omit the "$" sign in your response.)
c. What will be the value of your portfolio in January (net of the proceeds from the options) if the stock price ends up at $50? (Omit the "$" sign in your response.)
Compute the value of this stock in five years. Calculate the present value of these cash flows using a 10 percent discount rate.
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