Suppose a pension fund holds an investment in the S&P 500 for a total of $1m....
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Suppose a pension fund holds an investment in the S&P 500 for a total of $1m. The current spot price of the index is $3520/share. Afraid that the COVID-19 rally will fade, the investor has three alternatives: 1) sell all stock now to fully hedge the risk, 2) keep stock and buy a put option contract to fully hedge the risk (details of option - strike 3520, expiry 18-Dec-2020 for $200/share written on $1m worth of stock), and 3) keep stock and enter the following option combination involving two options (buy put with strike 3300, expiry 18-Dec-2020 for $100/share on $1m worth of stock and sell call with strike of $3700/share, expiry 18-Dec-2020 for $100/share on $1m worth of stock). Answer the following two questions: 1. Compute the total portfolio value (net value in price per share for stock investment plus/minus net option payoff) under three scenarios at the option maturity date of 18-Dec-2020: a) S&P 500 ends at $4000/share, b) S&P 500 ends at $3600/share, 3) S&P 500 ends at $3000. This is a quantitative response. 2. Suppose the actual outcome turns out to be b) above. Which is the best hedge strategy from an economic perspective? Why? This requires using information from the first question and then asks for qualitative response. Suppose a pension fund holds an investment in the S&P 500 for a total of $1m. The current spot price of the index is $3520/share. Afraid that the COVID-19 rally will fade, the investor has three alternatives: 1) sell all stock now to fully hedge the risk, 2) keep stock and buy a put option contract to fully hedge the risk (details of option - strike 3520, expiry 18-Dec-2020 for $200/share written on $1m worth of stock), and 3) keep stock and enter the following option combination involving two options (buy put with strike 3300, expiry 18-Dec-2020 for $100/share on $1m worth of stock and sell call with strike of $3700/share, expiry 18-Dec-2020 for $100/share on $1m worth of stock). Answer the following two questions: 1. Compute the total portfolio value (net value in price per share for stock investment plus/minus net option payoff) under three scenarios at the option maturity date of 18-Dec-2020: a) S&P 500 ends at $4000/share, b) S&P 500 ends at $3600/share, 3) S&P 500 ends at $3000. This is a quantitative response. 2. Suppose the actual outcome turns out to be b) above. Which is the best hedge strategy from an economic perspective? Why? This requires using information from the first question and then asks for qualitative response.
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To compute the total portfolio value we need to calculate the net value of the stock investment plus the net option payoff for each of the three scena... View the full answer
Related Book For
Accounting Principles
ISBN: 978-1119048473
7th Canadian Edition Volume 2
Authors: Jerry J. Weygandt, Donald E. Kieso, Paul D. Kimmel, Barbara Trenholm, Valerie Warren, Lori Novak
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