PROBLEM 1 You strongly believe

PROBLEM 1
You strongly believe that the price of Breener Inc. stock will raise substantially from its current level of $137, and you are considering buying shares in the company. You currently have $13,700 to invest. As an alternative to purchasing the stock itself, you are also considering buying call options on Breener Inc stocks that expires in three months and have an exercise price of $140. These call options cost $10 each.
a- Compare and contrast the size of the potential payoff and the risk involved in each of these alternatives.
b- Calculate the three-month rate of return on both strategies assuming that at the option expiration date Breener’s stock price has : (1)increased to $155 or (2)decreased to $135
c- At what stock price level will the person who sells you the Breener call option break even? Can you determine the maximum loss that the call option seller may suffer, assuming that he does not already own Breener stock?

PROBLEM 2
The common stock of company XYZ is currently trading at a price of $42. Both a put and call option are available for XYZ stock, each having an exercise price of $40 and an expiration date in exactly in 6 months. The current market prices for the put and call are $1.45 and $3.90 respectively. The risk-free holding period return for the next six months is 4%, which corresponds to an 8 percent annual rate.
a- For each possible stock price in the following sequence, calculate the expiration date payoffs (net of the initial purchase price) for the following positions: (1) buy one XYZ call option, and (2) short one XYZ call option: 20, 25, 30, 35, 40, 45, 50, 55, 60 Draw a graph of these payoff relationships, using net profit on the vertical axis and potential expiration date stock price on the horizontal axis. Be sure to specify the prices at which these respective positions will break even (i.e., produce a net profit of zero).
b- Using the same potential stock prices as in part a, calculate the expiration date payoffs and profits (net of initial purchase price) for the following positions: (1) buy one XYZ put option, and (2) short one XYZ put option.
Draw a graph of these relationships, labeling the prices at which these investments will break even.
c- Determine whether the $2.45 difference in the market prices between the call and the put options is consistent with the put-call parity relationship for the European-style contracts.

PROBLEM 3
Consider Commodity Z, which has both exchange-traded futures and option contracts associated with it. As you look in today’s paper, you find the following put and call prices for options that expire exactly six months from now: Exercise

Price Put Price Call Price 40 $0.59 $8.73 45 1.93 50 2.47

a- Assuming that the futures price of a six-month contract on Commodity Z is $48, what must be the price of a put with an exercise price of $50 in order to avoid arbitrage across markets? Similarly, calculate the “no arbitrage” price of a call with an exercise price of $45.
In both calculations, assume that the yield curve is flat and the annual risk-free rate is 6%.
b- What is the “no-arbitrage” price differential that should exist between the put and call options having an exercise price of $40. Is this differential satisfied by current market prices? If not, demonstrate and arbitrage trade to take advantage of the mispricing