# Question: Suppose that LMN Investment Bank wishes to sell Auric a

Suppose that LMN Investment Bank wishes to sell Auric a zero-cost collar of width 30 without explicit premium (i.e., there will be no cash payment from Auric to LMN). Also suppose that on every option the bid price is \$0.25 below the Black Scholes price and the offer price is \$0.25 above the Black-Scholes price. LMN wishes to earn their spread (\$0.25 per option) without any explicit charge to Auric.
What should the strike prices on the collar be? (Note: Since the collar involves two options, LMN is looking to make \$0.50 on the deal. You need to find strike prices that differ by 30 such that LMN makes \$0.50.)
•XYZ mines copper, with fixed costs of \$0.50/lb and variable cost of \$0.40/lb.
•Wirco produces wire. It buys copper and manufactures wire. One pound of copper can be used to produce one unit of wire, which sells for the price of copper plus \$5. Fixed cost per unit is \$3 and noncopper variable cost is \$1.50.
•Telco installs telecommunications equipment and uses copper wire fromWirco as an input. For planning purposes, Telco assigns a fixed revenue of \$6.20 for each unit of wire it uses.
The 1-year forward price of copper is \$1/lb. The 1-year continuously compounded interest rate is 6%. One-year option prices for copper are shown in the table below.17
In your answers, at a minimum consider copper prices in 1 year of \$0.80, \$0.90, \$1.00, \$1.10, and \$1.20.

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• CreatedAugust 12, 2015
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