Question

Which security should sell at a greater price?

a.  A 10-year Treasury bond with a 5% coupon rate or a 10-year T-bond with a 6% coupon.

• A 10-year Treasury bond with a 5% coupon rate

• A 10-year T-bond with a 6% coupon

b. A three-month expiration call option with an exercise price of $40 or a three-month call on the same stock with an exercise price of $35.

• A three-month call on the same stock with an exercise price of $35

• A three-month expiration call option with an exercise price of $40

c. A put option on a stock selling at $50 or a put option on another stock selling at $60. (All other relevant features of the stocks and options are assumed to be identical.)

• A put option on a stock selling at $50

• A put option on another stock selling at $60

Answer 1

1. A 10-year Treasury bond with a 5% coupon rate or a 10-year T-bond with a 6% coupon.

A 10-year T-bond with a 6% coupon, this security should sell at a greater price because if all other things are common, higher coupon bonds have higher prices. The higher coupon bonds have higher cash inflows which increases its price.

2. A three-month expiration call option with an exercise price of $40 or a three-month call on the same stock with an exercise price of $35.

A three-month call on the same stock with an exercise price of $35, this security should sell at a greater price because the call options with lower strike prices have more value.

Payoff of call option = underlying stock price - exercise price

Therefore if other things are identical, then lower strike price will increase the payoff of call option and its price also.

3. A put option on a stock selling at $50 or a put option on another stock selling at $60. (All other relevant features of the stocks and options are assumed to be identical.)

A put option on another stock selling at $60, this security should sell at a greater price because put options with higher strike prices have more value.

Payoff of Put option = Exercise price - underlying stock price

Therefore if other things are identical, then higher strike price will increase the payoff of put option and its price also.