BAF Assignment respond to the following questions:
1. A corporate treasurer is designing a hedging program involving foreign currency options.What are the pros and cons of using (a) NASDAQ OMX and (b) the over-the-countermarket for trading?
2. Suppose that a European call option to buy a share for $100.00 costs $5.00 and is held untilmaturity. Under what circumstances will the holder of the option make a profit? Underwhat circumstances will the option be exercised? Draw a diagram illustrating how the profitfrom a long position in the option depends on the stock price at maturity of the option.
3. Suppose that a European put option to sell a share for $60 costs $8 and is held untilmaturity. Under what circumstances will the seller of the option (the party with the shortposition) make a profit? Under what circumstances will the option be exercised? Draw adiagram illustrating how the profit from a short position in the option depends on thestock price at maturity of the option.
4. Describe the terminal value of the following portfolio: a newly entered-into long forwardcontract on an asset and a long position in a European put option on the asset with thesame maturity as the forward contract and a strike price that is equal to the forward priceof the asset at the time the portfolio is set up. Show that the European put option has thesame value as a European call option with the same strike price and maturity.
5. A trader buys a call option with a strike price of $45 and a put option with a strike priceof $40. Both options have the same maturity. The call costs $3 and the put costs $4. Drawa diagram showing the variation of the trader’s profit with the asset price.
6. Explain why an American option is always worth at least as much as a European optionon the same asset with the same strike price and exercise date.
7. Explain why an American option is always worth at least as much as its intrinsic value.
8. Explain carefully the difference between writing a put option and buying a call option.
9. The treasurer of a corporation is trying to choose between options and forward contracts tohedge the corporation’s foreign exchange risk. Discuss the advantages and disadvantagesof each.
10. Consider an exchange-traded call option contract to buy 500 shares with a strike price of$40 and maturity in 4 months. Explain how the terms of the option contract change whenthere is: (a) a 10% stock dividend; (b) a 10% cash dividend; and (c) a 4-for-1 stock split.
