Chapter 20

Derivative securities
TUTORIAL SOLUTIONSEND-OF-CHAPTER QUESTIONS AND PROBLEMS

3 a 100 1000 0.48 = $48 000

b 100 1000 (20 16) = $400 000

c (16 0.32) 20 1000 = $313 600 (net profit)

(16 15) 20 1000 = $20 000 (option value)

d (0.32 3.00) 20 1000 = $53 600 (loss)

$0.32 20 1000 = $64 00 (gain)
$0.32 = (16 P)
P = $15.68

5 (a) receives; obligation; buy

(b) pays; right; buy
(c) pays; right; sell
(d) receives; obligation; sell

6. False. The value of a call option depends on the total variance of the value of the
underlying asset. The call option will sell for more since it has higher potential
profit.

7. (a) The call options are in the money.

The intrinsic value, N = 12.00 9.60 = $2.40

(b) The Jan call should sell for a least $2.40:

Arbitrage: Buy call (1.80)
Exercise (9.60)
Sell share 12.00
Profit 0.60
(c) The January call shouldnt sell for more than the February call, so the most it
can sell for is a value less than $2.42.

8. There is an arbitrage opportunity. You can buy a call option for $0.95, exercise it
for $6.25, and then sell the share for $7.55. You will have made a profit of $0.35
per share.

Solutions Manual t/a Fundamentals of Corporate Finance 6e by Ross et al. 1

9 A call option confers the right, without the obligation, to buy an asset at a given
price on or before a given date. A put option confers the right, without the
obligation, to sell an asset at a given price on or before a given date. You would buy
a call option if you expected the price of the asset to increase. You would buy a put
option if you expected the price of the asset to decrease. A call option has unlimited
potential profit, while a put option has limited potential profit.

12. The call should sell for more as the potential profit is unlimited. The potential
profit for the put is limited to $10 per option less the cost of the premium.

13. The prices of both the call and the put option should increase. When the risk
increases, the value of the option when it finishes out of the money doesnt
change but the value of the option will be greater when it finishes in the money.

18. (a) C0 = 4.50 3.60/1.05 = $1.07

(b) C0 = 1.50/2.00 (4.50 4.00/1.05) = $0.518

Solutions Manual t/a Fundamentals of Corporate Finance 6e by Ross et al. 2