Question

Three Finance majors have differing opinions about TSLA stock, which currently trades at $700/share. Student 1 is very bullish (believes it will go way up) and decides to purchase shares of TSLA on margin. Student 2 feels the opposite and uses margin to sell short the same number of shares of TSLA. Student 3 isn’t sure but feels TSLA will be volatile over the next year and buys an ATM straddle. One year from today, TSLA trades at exactly $700/share. Which student(s), if any, will see a negative ROI on their investment strategy, under normal assumptions of transaction costs.

A-Student 2

B- All 3 students

C- None of the Students

D- Students 1 and 2

E- Students 2 and 3

F-Student 3

G- Student 1

H- Students 1 and 3

Answer 1

option (b) i.e all three students is the correct answer.

Student 1 has used margin to buy the stock at $700. since the stock price didn't move up, he will be in no profit no loss situation, however, he would be required to pay interest on margin money. Thus, his ROI will be negative

Similarly, student 2 has also used margin to short sell the shares. He will also be required to pay Interest on the borrowed amount.

Student 3 has taken a ATM Straddle (one call and one put option), since the price does not move up or down, he will lose the amount of premium paid on these straddle strategy. Thus, his ROI will also be negative.

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