ErenCo is an up-and-coming stone quarry company. A recent report, reflecting the general sentiment of all market participants, projected the following prices and probabilities for ErenCo stock on Aug. 20, 2021:

Probability 1/3 1/2 1/6

Stock Price $15 $10 $6

For each of the following questions, be sure to show all of your work.

2a.According to the EMH, what would you expect the market price of ErenCo stock to be today?

2b.Nancy, an investor in ErenCo, decides to buy a put option on ErenCo stock with a strike price (exercise price) of $9 which expires on Aug. 20. What would she have to pay in today's market for this option? In general, what determines the price an investor will have to pay for an option?

2c.Jeffrey Hotshot runs a large mutual fund that owns a lot of ErenCo's stock. He is concerned with maintaining the value of his investment in these volatile times. He plans on selling call options and using the proceeds to exactly offset what he plans on spending to buy put options. In this way he wants to ensure that he will always be able to sell his stock for at least $10 per share.

At what strike price will he have to sell his call options? Assume his expectations are the same as the market's, and that he will transact the same number of puts and calls.

Answer rating: 100% (QA)

2a According to the Efficient Market Hypothesis EMH the market price of a security reflects all available information about the stock including its expected future performance To determine the expecte... View the full answer