1. You write a put option on a stock for a premium of $1. The exercise price is
ID: 2731948 • Letter: 1
Question
1. You write a put option on a stock for a premium of $1. The exercise price is $6.50. What is the option’s profit or loss if just prior to expiration the stock price is $6.00? a. $0.50 b. $1.00 c. ($1.00) d. ($0.50) e. $0 2. Which of the following values comes closest to the net present value of a project that requires an initial investment of $250 and produces cash flows of $60 per year for 10 consecutive years beginning at the end of year 5 (the cash flows go from the end of year 5 through the end of year 14)? The required rate of return is 10%? a. ($34.55) b. $1.81 c. ($17.23) d. ($64.70) e. ($50.32)Explanation / Answer
1. put option is an option where it gives a right to sell a stock at pre decided price to buyer of it. Thus it creates an obligation to buy a securtity to the writer ( put option seller) So writer gets premium of $1 and he loses $0.5 on buying it at strike price of $6.5 when market price was $ 6.
Therefore over all profit to the writer is $0.5 Hence option a) is correct.
2) present value of $ 60 when we discount it at 10% for years from year 5 to 14 is 60* 4.1968220 = $251.81
Hence NPV = $ 251.81 - $250 = $ 1.81
Hence answer is option B.
You can get 4.1968220 by adding ( 1/(1.1)^5 + 1/(1.1)^6 + . . . 1/(1.1)^14)
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