Question

Please show work.

The current price of a stock you are holding is $80. You want to continue to hold the stock position but modify it (by including bond holding) so that the resulting portfolio value never drops below $72. The rate of simple interest for the period is 10%.

If the stock may move up to $104 or down to $64 after one period, how do you modify our initial holding of $80 so as to make sure that it is at least worth $72 at the end of the period? The rate of simple interest for the period is 10%.

What is the actual cost of the above strategy? Hint: What is your terminal payoff when the stock moves up?

Answer 1

Here,

i = 1 + Interest = 1.10

d = = = 0.89

u = = = 1.44

Cu = Higher Price = 104

Cd = Lower Price = 64; But when price will be 64 the option will not be taken Hence 0

So = Spot Price = 80

E = Exercise Price = 72

Now,

Cost of the strategy

=

=

= $36.10