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FINA3080 Assignment 1 Q&A

1) A price-weighted index of three stocks had a 4.17% return from period 0 to 1. In period 2, stock C split 2-for-1 requiring a divisor adjustment of the index to 2.34. The return for period 1 to 2 was 0%. 2) For an Apple call option expiring in October with a $100 strike price, exercising would yield a 129% return if the stock price was $106 in October. 3) For an investor who purchased 300 shares of a stock costing $40 per share using $4,000 borrowed at 6% interest, the ending margin would be 52.89% if the stock fell to $30, and they would

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123 views4 pages

FINA3080 Assignment 1 Q&A

1) A price-weighted index of three stocks had a 4.17% return from period 0 to 1. In period 2, stock C split 2-for-1 requiring a divisor adjustment of the index to 2.34. The return for period 1 to 2 was 0%. 2) For an Apple call option expiring in October with a $100 strike price, exercising would yield a 129% return if the stock price was $106 in October. 3) For an investor who purchased 300 shares of a stock costing $40 per share using $4,000 borrowed at 6% interest, the ending margin would be 52.89% if the stock fell to $30, and they would

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FINA3080A Assignment 1 Q&A

Ch 2

1. Consider the three stocks in the following table. Pt represents price at time t, and Qt
represents shares outstanding at time t. Stock C splits two-for-one in the last period.

P0 Q0 P1 Q1 P2 Q2
A 90 100 95 100 95 100
B 50 200 45 200 45 200
C 100 200 110 200 55 400

a. Calculate the rate of return (%) on a price-weighted index of the three stocks for the first
period (from t=0 to t=1 by calculating the index at t=0 and t=1)
b. Calculate the divisor (initially equal to three) for the price-weighted index in year 2?
c. Calculate the rate of return (%) of the price-weighted index for the second period (t=1 to
t=2).
d. Calculate the first-period (t=0 to t=1) rates of return (%) on the following index of the
three stocks using market value–weighted index.
e. Calculate the first-period (t=0 to t=1) rates of return (%) on the following index of the
three stocks using equally weighted index.

ANS

a. At t = 0, the value of the index is: ($90 + $50 + $100)/3 = 80


At t = 1, the value of the index is: ($95 + $45 + $110)/3 = 83.33
V1
The rate of return is: V 0 － 1 = (83.3333/80) – 1 = 0.0417 or 4.17%

b. In the absence of a split, stock C would sell for $110, and the value of the index
would be the average price of the individual stocks included in the index:
($95 + $45 + $110)/3 = $83.33.
After the split, stock C sells at $55; however, the value of the index should not be
affected by the split. We need to set the divisor (d) such that:
83.33 = ($95 + $45 + $55)/d
d = 2.34

c. The rate of return is zero. The value of the index remains unchanged since the
return on each stock separately equals zero.

d. Total market value at t = 0 is:


($90 x 100) + ($50 x 200) + ($100 x 200) = $39,000

Total market value at t = 1 is:


($95 x 100) + ($45 x 200) + ($110 x 200) = $40,500
V1
Rate of return = V 0 － 1 = ($40,500/$39,000) – 1 = 0.0385 or 3.85%
e. The return on each stock is as follows: student may assume investing equally to get
the same answers
V1
RA = V 0 － 1 = ($95/$90) – 1 = 0.0556 or 5.56%
V1
RB = V 0 － 1 = ($45/$50) – 1 = –0.10 or –10.00%

V1
RC = － 1 = ($110/$100) – 1 = 0.10 or 10.00%
V0
The equally-weighted average is: [5.56% + (–10.00%) + 10.00%]/3 = 1.85%

2. Look at the Apple options from below. Suppose you buy an October expiration call option
with exercise price $100.

Apple (AAPL) Underlying stock price, S = $102.05


Expiration Strike (E) Call Put
September 95 6.20 0.21
October 95 6.35 0.33
September 100 2.20 1.18
October 100 2.62 1.55
September 105 0.36 4.35
October 105 0.66 4.75

a. If the stock price in October is $106, will you exercise your call? What are the net profit
and the rate of return (%) if you exercise the call? Ignore time value of money.
b. Will you exercise the call if you had bought the October call with exercise price $95? No
explanation needed.
c. Will you exercise the option if you had bought an October put with exercise price $100?
No explanation needed.

Ans
a. Yes, profit from exercising , S-E =106 – 100=6 , net profit =6 – 2.62 = 3.38, return =
3.38/2.62=1.29 or 129%
b. Yes, E<S.
c. No, S>E.

Ch 3
3. Mary opens a brokerage account and purchases 300 shares of Internet Dreams at
$40 per share. She borrows $4,000 from her broker to help pay for the purchase. The
interest rate on the loan is 6%.

a. What is the margin in $ (i.e. the initial deposit in $) in Mary’s account when she first
purchases the stock?
b. If the share price falls to $30 per share by the end of the year, what is the remaining
margin in her account? If the maintenance margin requirement is 30%, will she receive a
margin call? Note: you have to pay 6% interest a year, i.e. the amount borrowed will be
6% more by the end of year, this will affect your equity at the time.
c. What is the rate of return (%) on her investment? Hint: calculate the ending and
beginning equity in your account.

Ans
a. The stock is purchased for $40  300 shares = $12,000.
Given that the amount borrowed from the broker is $4000, Dee’s margin is
the initial purchase price net borrowing: $12,000 – $4,000 = $8,000.

b. If the share price falls to $30, then the value of the stock falls to $9,000. By
the end of the year, the amount of the loan owed to the broker grows to:
Principal  (1 + Interest rate) = $4,000  (1 + 0.06) = $4240.
The value of the stock falls to: $30  300 shares = $9,000.
The remaining margin in the investor’s account is:
Equity in a ccount
Margin on long position =
Value of s tock
$9,000 － $4240
= $9,000 = 0.5289 = 52.89%

Therefore, the investor will not receive a margin call.

Ending e quity in a ccount － Initial equity in account


c. Rate of return =
Initial e quity in a ccount
$ 4760 － $ 8 ,00 0
= = – 0.405 = – 40.5%
$ 8 ,000

Note: Ending equity in account = 9000 – (amount borrowed + interest)

4. You opened an account to short-sell 1,000 shares of Internet Dreams from the previous
question. The initial margin requirement was 50%. (The margin account pays no interest.) A
year later, the price of Internet Dreams has risen from $40 to $50.

a. What is the remaining margin (in $) in the account?


b. If the maintenance margin requirement is 30%, will you receive a margin call?
c. What is the rate of return (%) on the investment?

ANS

a. The initial margin was: $40 x 1,000  0.50 = $20,000.


As a result of the $10 increase in the stock price, you lose: $10  1,000 shares
= $10,000.
The remaining margin in the investor’s account therefore decreases to:
$20,000 – $10,000 = $10,000.

Equity
b. Margin on short position =
Value of s hares o wed
$ 10,000
= $ 50 1 ,000 shares = 0.2=20%

Because the percentage margin falls below the maintenance level of 30%,
there will be a margin call.

Ending e quity － Initial equity


c. The rate of return =
Initial e quity
$10 , 000 － $20,00 0
= $ 2 0 ,000 = -0.50=-50%

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