Finance - Discuss the risks and payoffs
Please answer one of the following questions in detail, providing examples whenever applicable.
1. Discuss the risks and payoffs of the following positions, accompanied by payoff graphs.
· Buy stock and a put option on the stock.
· Buy a stock.
· Buy a call.
· Buy stock and sell a call option on the stock (covered call).
· Buy a bond.
· Buy stock, buy a put, and sell a call.
· Sell a put (naked put).
2. Over the coming year, Ragwort’s stock price might drop from $100 to $50, or it might rise to $200. The one-year interest rate is 10%.
· What is the delta of a one-year call option on Ragwort stock with an exercise price of $100?
· Use the replicating-portfolio method to value this call.
· In a risk-neutral world, what is the probability that Ragwort stock will rise in price?
· Use the risk-neutral method to check your valuation of the Ragwort option.
· If someone told you that, in reality, there is a 60% chance that Ragwort’s stock price will rise to $200, would you change your view about the value of the option? Explain.