C. Decide on an appropriate asset allocation from the following securities only
ID: 2779607 • Letter: C
Question
C. Decide on an appropriate asset allocation from the following securities only (show ranges for allocations):
Security
Expected Return
Standard Deviation
Money Market
1.5%
1%
Passive Equities
9%
14%
Investment Graded Bonds
7%
10%
Actively Managed Equities
11%
18%
Equity Call Options
25%
50%
D. One year later, the triplets are off to college and Kara has completed her first year of nursing school. Stephen was recently honored Major League Baseball for his community work and part of the award is 100 shares of stock in Cleveland Indians franchise. Stephen is nervous about owning individual stocks but does not want to sell the shares to offend either the major League or Cleveland.
Show how Stephen can use a put option on Cleveland stock to hedge the risk of equity ownership. Assume a stock price of $8, exercise price of $6, and one-year to expiration. Show the hedging results of the price of the shares is either $10 or $3 at expiration in one year.
Security
Expected Return
Standard Deviation
Money Market
1.5%
1%
Passive Equities
9%
14%
Investment Graded Bonds
7%
10%
Actively Managed Equities
11%
18%
Equity Call Options
25%
50%
Explanation / Answer
Soln: D) As Stephen is owning the shares, and buying the put option .
As exercise price is $6 and as per scenario price of share = $10, in that case if he has bought the Put, he will not utilize the put option and gain 10*100 = $1000
In case if price goes down to $3, still he can sell it using Put option at rate of $6 and can earn = $600.
For part c more information required like return required and risk taking limitation which is not given, kindly provide to solve this.
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