(b) (4 points) Mr. Buss’s Inc. will pay out a dividend of $9 every 2 years, starting in 5 years. The company will go out of business 50 years from today, and pay its shareholders $1,000 per share. No dividend payments will be made after the company goes out of business. 16. (6 points) Isaias buys one share of stock at a price of $80 today, and two put options with an exercise price of $40 two years from now. (In other words, the expiration date of the option is two years from now.) The put option is for selling one share. For simplicity in this problem, you can assume that the discount rate is 0%. Draw a well-labeled graph that shows the value of a combination of the two shares of stock and the put option as a function of the value of stock at expiration. The vertical intercept should have the value of the combination of the stock and the put options. The horizontal intercept should have the value of the stock at the expiration. Make sure to label your intercepts and other relevant numbers on each axis, where relevant. (Hint: You may want to look at the front page of the test to see a well-labeled graph.) Explain your answer in words, math, and/or using additional graphs. 17. (6 points) Mary Ann has just won the Super Wacky Lottery jackpot. She is given two choices: (1) Receive a monthly payment of $10,000 (starting today) or (2) Receive a one-time lump sum payment today of $1,000,000. If Mary Ann’s stated annual discount rate is 6%, compounded monthly, what is the minimum number of monthly payments she must receive in order to do better with the first option? 18. (6 points) Pump With Pride and Love, Inc. stock currently sells for $60 per share. Each of the next 4 years, the value of the stock will go up or down by $5, each with 50% probability. Ron buys a European call option with expiration date 4 years from today. The exercise price on this option is $69. What is the present value of this option if the effective annual interest rate is 25%? NOTE: YOU CAN TEAR THIS SHEET OFF SHEET WILL NOT BE GRADED UNLESS AND USE AS EXTRA SCRATCH PAPER. EXPLICITLY SPECIFIED ON THE TEST. PLEASE NOTE THAT ANYTHING ON THIS
(b) (4 points) Mr. Buss’s Inc. will pay out a dividend of $9 every 2 years, starting in 5 years. The company will go out of business 50 years from today, and pay its shareholders $1,000 per share. No dividend payments will be made after the company goes out of business. 16. (6 points) Isaias buys one share of stock at a price of $80 today, and two put options with an exercise price of $40 two years from now. (In other words, the expiration date of the option is two years from now.) The put option is for selling one share. For simplicity in this problem, you can assume that the discount rate is 0%. Draw a well-labeled graph that shows the value of a combination of the two shares of stock and the put option as a function of the value of stock at expiration. The vertical intercept should have the value of the combination of the stock and the put options. The horizontal intercept should have the value of the stock at the expiration. Make sure to label your intercepts and other relevant numbers on each axis, where relevant. (Hint: You may want to look at the front page of the test to see a well-labeled graph.) Explain your answer in words, math, and/or using additional graphs. 17. (6 points) Mary Ann has just won the Super Wacky Lottery jackpot. She is given two choices: (1) Receive a monthly payment of $10,000 (starting today) or (2) Receive a one-time lump sum payment today of $1,000,000. If Mary Ann’s stated annual discount rate is 6%, compounded monthly, what is the minimum number of monthly payments she must receive in order to do better with the first option? 18. (6 points) Pump With Pride and Love, Inc. stock currently sells for $60 per share. Each of the next 4 years, the value of the stock will go up or down by $5, each with 50% probability. Ron buys a European call option with expiration date 4 years from today. The exercise price on this option is $69. What is the present value of this option if the effective annual interest rate is 25%? NOTE: YOU CAN TEAR THIS SHEET OFF AND USE AS EXTRA SCRATCH PAPER. PLEASE NOTE THAT ANYTHING ON THIS SHEET WILL NOT BE GRADED UNLESS EXPLICITLY SPECIFIED ON THE TEST.
Test3A_Spring2016.docx