A long-time client, an insurance salesperson, has noticed the increased acquisit

Question

A long-time client, an insurance salesperson, has noticed the increased acquisition activity involving commercial banks. Your client wishes to capitalize on the potential gains associated with this increased acquisition activity in the banking industry by creating speculative positions using options. Your client realizes that bank cash flows are sensitive to changes in interest rates, and he/she believes that the Federal Reserve is about to increase short-term interest rates. Realizing that an increase in the short-term interest rates will lead to a decrease in the stock prices of commercial banks, your client wants the value of his/her portfolio of options to be unaffected by changes in short-term interest rates. Explain how the investor can use option contracts to protect his/her portfolio against changes in value due to changes in the risk-free rate, and to capitalize on the expected price changes in bank stocks

Explanation / Answer

An options contract is an agreement between a buyer and seller that gives the purchaser of theoption the right to buy or sell a particular asset at a later date at an agreed upon price. Options contracts are often used in securities, commodities, and real estate transactions.

Since option premium reduces the risk of volatility in price fluctuation therefore it is benificial to to the investors.Option enable investors to stump up less money and obtainadditional gain.It may be use to limit the losses and it also used to enhance a portfolio's return.One can replicate an actual stock portfolio with the options on those very stocks.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.