Please use an Excel spreadsheet to arrive at the answers.Please email me the Excel spreadsheet on the due date together with your answers to the questions.

• The current price of stock in Company XYZ is $45 and no ex-dividend dates are to occur for the next three months. The risk-free rate is 4.00% per year.The standard deviation for the period in question is 0.4.You are a financial advisor and one of your best clients is Mr. John Smith who is a senior-level manager at a Fortune 500 company.A portion of Mr. Smith's incentive compensation is paid in restricted stock in the company he works for which he cannot sell for a period of three years from the date of the award of the shares.Smith has been employed at the company for 35 years and he has been in a senior position for the last 20 years.Mr. Smith has a concentrated equity position in the company owning 1,000,000 shares.More than 80% of his wealth is in the company stock.Assume that due to contractual obligations, he cannot sell his stock over the next three months.Due to his concentrated position, he wants to hedge against the price of XYZ stock falling more than 20%.He can do this by buying put options with a strike price of $36.

1. Assume that Mr. Smith does not have the necessary amount of liquid assets (other than his stock which he cannot sell) to be able to purchase these put options so he will have to enter into an equity collar. At what strike price should he strike the corresponding call options?
2. If Mr. Smith decides that he can raise enough cash to put up $200,000 to pay for some of the puts, how will it affect the strike price on the call?
3. If instead of three months, the restriction on his stock is six months, how will this change the hedge? Solve for the appropriate put and call strikes.
4. Using your answers from a) above, assume that after one month, the stock price goes up to $70 and Mr. Smith wants to unwind his hedge. Describe how you would go about terminating this hedge.Determine what it would cost to terminate this hedge.
5. Again, using your answers from a) above, if after one month the stock price went down to $28 instead and Mr. Smith wanted to terminate this hedge, what would be the economic repercussions? Calculate this amount.
6. As Mr. Smith's financial advisor, would you recommend this strategy to Mr. Smith? Why or why not?
7. List down the benefits and advantages of this strategy.
8. As part of your fiduciary responsibility as a financial advisor, you also have to disclose the risks and disadvantages associated with this strategy. List them all down and discuss how you would present them to your client.

• Price up an American call with strike price K = $105 (expiring in 4 periods) on the following stock. Each period is 3 months long:

The current stock price is $95

The standard deviation is 0.35

There will be dividends of 3.25% of the stock price whether it goes up or down in periods 1 and 3.

The risk free rate is 4.00% per year.

How will your analysis change if the standard deviation is increased to 0.50?Please illustrate both the stock price tree/lattice and the call premium tree/lattice on your Excel spreadsheet so it is easy to see each step.

1. Having performed your calculations and your analysis, are there any opportunities you can identify that you can take advantage of as an investor?
2. Describe a strategy that you would like to implement and/or a portfolio that you can form that can yield attractive returns
3. Describe the benefits and risks of the strategy/ies that you would like to implement
4. Without actually doing the calculations, are you able to perform a similar kind of analysis using the Black-Scholes-Merton model instead of the Binomial Option Pricing model? What are the advantages and disadvantages of using one over the other?Mention some of the limitations of each model in answering the above questions.