Diversification is achieved by investing in a large amount of stocks. What type of risk is reduced by diversification?
Question 237 WACC, Miller and Modigliani, interest tax shield
Which of the following discount rates should be the highest for a levered company? Ignore the costs of financial distress.
When using the dividend discount model, care must be taken to avoid using a nominal dividend growth rate that exceeds the country's nominal GDP growth rate. Otherwise the firm is forecast to take over the country since it grows faster than the average business forever.
Suppose a firm's nominal dividend grows at 10% pa forever, and nominal GDP growth is 5% pa forever. The firm's total dividends are currently $1 billion (t=0). The country's GDP is currently $1,000 billion (t=0).
In approximately how many years will the company's total dividends be as large as the country's GDP?
"Buy low, sell high" is a phrase commonly heard in financial markets. It states that traders should try to buy assets at low prices and sell at high prices.
Traders in the fixed-coupon bond markets often quote promised bond yields rather than prices. Fixed-coupon bond traders should try to:
An economy has only two investable assets: stocks and cash.
Stocks had a historical nominal average total return of negative two percent per annum (-2% pa) over the last 20 years. Stocks are liquid and actively traded. Stock returns are variable, they have risk.
Cash is riskless and has a nominal constant return of zero percent per annum (0% pa), which it had in the past and will have in the future. Cash can be kept safely at zero cost. Cash can be converted into shares and vice versa at zero cost.
The nominal total return of the shares over the next year is expected to be:
Question 793 option, hedging, delta hedging, gamma hedging, gamma, Black-Scholes-Merton option pricing
A bank buys 1000 European put options on a $10 non-dividend paying stock at a strike of $12. The bank wishes to hedge this exposure. The bank can trade the underlying stocks and European call options with a strike price of 7 on the same stock with the same maturity. Details of the call and put options are given in the table below. Each call and put option is on a single stock.
European Options on a Non-dividend Paying Stock | |||
Description | Symbol | Put Values | Call Values |
Spot price ($) | ##S_0## | 10 | 10 |
Strike price ($) | ##K_T## | 12 | 7 |
Risk free cont. comp. rate (pa) | ##r## | 0.05 | 0.05 |
Standard deviation of the stock's cont. comp. returns (pa) | ##\sigma## | 0.4 | 0.4 |
Option maturity (years) | ##T## | 1 | 1 |
Option price ($) | ##p_0## or ##c_0## | 2.495350486 | 3.601466138 |
##N[d_1]## | ##\partial c/\partial S## | 0.888138405 | |
##N[d_2]## | ##N[d_2]## | 0.792946442 | |
##-N[-d_1]## | ##\partial p/\partial S## | -0.552034778 | |
##N[-d_2]## | ##N[-d_2]## | 0.207053558 | |
Gamma | ##\Gamma = \partial^2 c/\partial S^2## or ##\partial^2 p/\partial S^2## | 0.098885989 | 0.047577422 |
Theta | ##\Theta = \partial c/\partial T## or ##\partial p/\partial T## | 0.348152078 | 0.672379961 |
Which of the following statements is NOT correct?
Question 807 market efficiency, expected and historical returns, CAPM, beta, systematic risk, no explanation
You work in Asia and just woke up. It looked like a nice day but then you read the news and found out that last night the American share market fell by 10% while you were asleep due to surprisingly poor macro-economic world news. You own a portfolio of liquid stocks listed in Asia with a beta of 1.6. When the Asian equity markets open, what do you expect to happen to your share portfolio? Assume that the capital asset pricing model (CAPM) is correct and that the market portfolio contains all shares in the world, of which American shares are a big part. Your portfolio beta is measured against this world market portfolio.
When the Asian equity market opens for trade, you would expect your portfolio value to:
Question 823 option, option payoff at maturity, option profit, no explanation
A European call option should only be exercised if:
A non-dividend paying stock has a current price of $20.
The risk free rate is 5% pa given as a continuously compounded rate.
Options on the stock are currently priced at $5 for calls and $5.55 for puts where both options have a 2 year maturity and an exercise price of $24.
You suspect that the call option contract is mis-priced and would like to conduct a risk-free arbitrage that requires zero capital. Which of the following steps about arbitraging the situation is NOT correct?
Examine the below graph.
Which of the below statements is NOT correct?