Question

Imagine you have $2000 to invest. There are two companies' stocks that are available. Stock A is currently selling for $50 and will either go up to $75 or down to $40. Stock B is currently selling for $100 and will either go up to $130 or down to $80. Consider the following strategies

f. Short sell $1000 of corporation A and put all $3000 in corporation B.

What are your possible payoffs? What are your possible returns?

Answer 1

The four possibilites that is possibe is

1) Stock A goes up and Stock B goes Up

2) Stock A goes down and Stock B goes Up

3) Stock A goes down and Stock B goes Down

4) Stock A goes up and Stock B goes Down

Also the number of stock sold for A = Amount of short posistion /price per share of stock A= 1000/50= 20

Also the number of stock Purchsed for B = Amount of Investement /price per share of stock B= 3000/100= 30

Payoff at each of the possibilites is given as-

1) Pay of stock A if stock price goes up to 75 = (Sale price - Price it will go to in future)* Number of share

=(50-75)*20=-500

Pay of stock B if stock price goes up to 130 = ( Price it will go to in future-Purchase price )* Number of share

=(130-100)*30=900

Total pay off =-500+900= 400

2) Pay of stock A if stock price goes down to 40 = (Sale price - Price it will go to in future)* Number of share

=(50-40)*20=200

Pay of stock B if stock price goes up to 130 = ( Price it will go to in future-Purchase price )* Number of share

=(130-100)*30=900

Total pay off =200+900= 1100

3) Pay of stock A if stock price goes down to 40 = (Sale price - Price it will go to in future)* Number of share

=(50-40)*20=200

Pay of stock B if stock price goes down to 80 = ( Price it will go to in future-Purchase price )* Number of share

=(80-100)*30=-600

Total pay off =200-600= -400

4) Pay of stock A if stock price goes up  to 75 = (Sale price - Price it will go to in future)* Number of share

=(50-75)*20=-500

Pay of stock B if stock price goes down to 80 = ( Price it will go to in future-Purchase price )* Number of share

=(80-100)*30=-600

Total pay off =-500-600= -1100

The Pay off at each of the four possibilites are

1) Stock A goes up and Stock B goes Up= 400

2) Stock A goes down and Stock B goes Up=1100

3) Stock A goes down and Stock B goes Down= -400

4) Stock A goes up and Stock B goes Down= -1100

Possible returns is given as = Payoff / Investement

Possible return at each of the possibilties is given as

1) Stock A goes up and Stock B goes Up= 400/2000=20%

2) Stock A goes down and Stock B goes Up=1100/2000=55%

3) Stock A goes down and Stock B goes Down= -400/2000= -20%

4) Stock A goes up and Stock B goes Down= -1100/2000= -55%