Question

3) Assume Disney stock is trading at $100/share today but you believe its price will fall in the very near future to $80/share. If this is all you believe and assuming you want to make money, describe in great detail how you could profit from this belief. Make sure to use the correct terminology.

4) Assume you buy a $1,000 Par, 5% coupon, 10-year bond has when its trading at a Yield To Maturity (YTM) of 4%. If you sell it two years later (when it has a maturity of 8 years) when it’s YTM is 3.5% what is your Profit or loss in dollars, _____________________

Answer 1

Qstn 3) Assume Disney stock is trading at $100/share today but you believe its price will fall in the very near future to $80/share. If this is all you believe and assuming you want to make money, describe in great detail how you could profit from this belief. Make sure to use the correct terminology.

Answer:

Given that the current stock price of Disney is $100 and also that the price in the near future would fall to $80. If i would have to make money in this scenario then i would do the following:

1. If the price is headed downwards then i would buy a PUT OPTION on the Disney stock for the expiry happening in two months by paying a premium. I would lock in the premium at the strike price of $100, so that when the stock starts falling the premium on my PUT Option starts to rise and i would be able to make money out of it. I would look at an American Option and the payoff from the put option would be Max(K-S_T, 0) and also deducting the premium paid.This would be the strategy when i am confident about the down trend of the stock.

2. If i am not very sure that whether the price would actually fall or not, to be on the safer side then i would buy the stock of Disney at $100, and at the same time to benefit from the downside would Hedge my position by getting into buying a PUT Option for the strike price of $90. If the stock does not moves upwards then i would loose my premium paid and at the same time would make a gain on the stock that i hold. If the stock moves downwards then the loss on the stock would be offset with the gain made by PUT Option.

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Qstn 4) Assume you buy a $1,000 Par, 5% coupon, 10-year bond has when its trading at a Yield To Maturity (YTM) of 4%. If you sell it two years later (when it has a maturity of 8 years) when it’s YTM is 3.5% what is your Profit or loss in dollars

Answer

Given the YTM;s at two different time periods, so let us find the price at these two different time periods, then the difference of the price would be our gain or loss respectively.

Price of the bond in the first year. -> (50/1.04)+1000 = $1048.077

Price of the bond at the end of third year i.e. after two years -> (50/1.04)+(50/1.04)^2+(50/1.04)^3+(1050/1.04)^3 = $1072.201.

Therefore the difference is $24.12 and it is a gain.

Also as the YTM's are decreasing and it is lower than the coupon rate, hence the price of the bonds shall always be increasing hence we see a profit of $24.12.