Question

Mr. John Hailey has $800 to invest in the market. He is considering the purchase of 80 shares of Comet Airlines at $10 per share. His broker suggests that he may wish to consider purchasing warrants instead. The warrants are selling for $2, and each warrant allows him to purchase one share of Comet Airlines common stock at $20 per share.

a. How many warrants can Mr. Hailey purchase for the same $800? (Do not round intermediate calculations and round your answer to the nearest whole number.)
Number of warrants purchased_______ warrants

b. If the price of the stock goes to $30, what would be his total dollar and percentage return on the stock? (Do not round intermediate calculations. Round the first answer to the nearest whole dollar. Input the second answer as a percent rounded to 2 decimal places.)

Total dollar return on the stock ________

Percentage return on the stock ________ %

c. At the time the stock goes to $30, the speculative premium on the warrant goes to 0 (though the market value of the warrant goes up). What would be Mr. Hailey’s total dollar and percentage returns on the warrant? (Do not round intermediate calculations. Round the first answer to the nearest whole dollar. Input the second answer as a percent rounded to 2 decimal places.)

Total dollar return on the warrant_______

Percentage return on the warrant_______%

d. Assuming that the speculative premium remains $3.50 over the intrinsic value, how far would the price of the stock have to fall from $30 before the warrant has no value? (Do not round intermediate calculations and round your answer to 2 decimal places.)

New Stock price_________

Answer 1

a)

warrant price = $2

amount to invest = $800

number of warrants can be purchased = 800 / 2 = 400

b)

current price = $10

future price = $30

gain in % = (30 - 10) / 10 = 200%

in dollars = 800 * 200% = $1600

c)

number of warrants = 400

profit per warrant = 30 - 20 - 2 = $8 (formula = current price - option pricce - warrant price)

total profit = 400 * 8 = $3200

Total dollar gain = $3200

in % = (3200 / 800)*100 = 400%

d)

as per aboove calculation profit per warrant = $8

speculative premium = $3.50

falling in price = profit per warrant - speculative premium

= 8 - 3.50

= $4.50

new stock price = 30 - 4.50 = $25.50