1. Assume that you purchase a call option costing $10/share which would allow yo
ID: 2801980 • Letter: 1
Question
1. Assume that you purchase a call option costing $10/share which would allow you to purchase 100 shares of stock at a strike price of $90. If, at the exercise date, the stock was trading at $115, would you exercise the option? What would be your return? What about if the stock was trading at $95 on the exercise date?
2. Assume that Fund A charges a front-end load of 6%, an expense ratio of 0.4% and no 12b-1 fees. Assume that Fund B charges no front-end load, 12b-1 fees of 0.5% an expense ratio of 1% and back-end fees of 2%. If both funds’ portfolios have an average return of 12%, which is the better investment after 5 years given an initial investment of $5,000?
Explanation / Answer
1)
If stock price on the expiration is date higher than strike price, option will be exercised and vice-versa.
Stock price is $115, strike price is $90 – Option will be exercised.
Profit on option is $15 ($115-$90-$10) and rate of return is 150% ($115-$90-$10)/$10.
Stock price is $95, strike price is $90 – Option will be exercised.
Profit on option is -$5 ($95-$90-$10) and rate of return is -50% ($95-$90-$10)/$10.
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