An Excel model based on the FinCorp example discussed in the text is shown below. The model allows you to use any variety of options, stock, and lending or borrowing with a set investment amount and dem tes the investment flexibility of options.

Spreadsheets are available in Connect

$10,500

$11,000 18,000

A Current

B

C

D

E

G

H

9,000

13,500

90

9,660

10.160

9,160

stock price

2 Exercise price

interest rate

4investment budget

Call price

99

0.02

9000

10

folio B is worthless unless the

int, the portfolio is worth 900

lly, portfolio C is worth $8,160

any profits from the 100 call

same $9,000 initial investment..

Portfolio

9 Portfolio A All stock 50 Portfolio B: All call options Portfolio C Call plus bills

Dollar value of portfolio as a function of FinCorp $90 $95 $100

price

$85

$105 $110

$8,500 $9,000 $9.500 $10,000 $10,500 $11,000 0 4,500 9,000 13,500

18,000

8.160 8,160

8,660 9.160 9,660 10,160

12

513

15 Portfolio

Portfolio A All stock 17 Portfolio B All call options 18 Portfolio C Call plus bills

Rate of return as a function of FinCorp price $95 $100 $105

$85 $90

-5.6%

0.00% 5.6% 11.1% 0.0% 50.0%

16.7%

-100.0%-100.0%

-50.0%

-9.33%

-9.33% -3.78% 1.78% 7334

$110

22 2%

100.0%

12.89%

Excercise: 80. Ell: 15

e

Excel Questions

100

$105

$110

1.11% 00

16.67% 50.0

22.22% 100.0

1 Plot the rate of return to the call-plus-bills strategy using a diagram like that in Figure 15.5 but now assuming the investor uses an in-the-money call option with a strike price of $80. Assume the calls sell for $15. The higher cost for these calls compared to the at-the-money calls will result in less money being placed in T-bills because the investment budget is still $9.000.

2 Compare the plots of rate of return for the strategies using at-the-money calls (as in Figure 15.5) and your solution to Question 1. Which strategy is riskler?

1.78

7.33

12.89

In this sense, calls are a levered investment on the stock. Their values respond more than pro portionately to changes in the stock value. Figure 15.5 vividly illustrates this point. For stock prices above $90, the slope of the all

me simple investment in stock

ting features. First, an

option

option portfolio is far steeper than that of the all-stock portfolio, reflecting its greater propor

In the stock fares poorly, end

usly to zero-a rate of return

return on the stock result in

mple, a 4.8% increase in the

fional sensitivity to the value of the underlying security. The leverage factor is the reason that

investors

(illegally) exploiting inside information commonly choose options as their invest

100%