Question

1. Chester bought a put on LKG stock with a strike price of $35 when the market price of LKG stock was $33 a share. LKG is currently selling at $34 a share. Which of the following statements are true given this information?

   I. Chester's option is worth at least $100 today

   II. Chester's option is worth nothing today.

   III. Chester's option has more value today than when he bought it.

   IV. Chester's option has less value today than when he bought it.
   
   

   		II and III only
   		I and IV only
   		II and IV only
   		I and III only

What is the required rate of return on a common stock that is expected to pay a $1.87 annual dividend next year if dividends are expected to grow at 7 percent annually and the current stock price is $48.53?

		9.73%
		11.73%
		12.07%
		10.85%

Answer 1

The value of the put option is computed as shown below:

= Strike Price - Price at expiration

Value at the time of purchase was as follows:

= ($ 35 - $ 33) x 100

= $ 200

Current Value is as follows:

= ($ 35 - $ 34) x 100

= $ 100

So, as can be seen the value of the put option is worth at least $ 100 today, but the value of the put option decreased as compared to the value when it was purchased.

So, the correct answer is option of I and IV only

The required return is computed as shown below:

= Expected dividend / current stock price + growth rate

= $ 1.87 / $ 48.53 + 0.07

= 10.85% Approximately

Feel free to ask in case of any query relating to this question