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Deeg Inc: Calculation of Investment in Shares and Options

You are a portfolio manager and you are of the opinion that Deeg Inc. shares will rise from its current levels of R200. You
are seriously considering purchasing some of these shares. You currently have R400 000 to invest. You are also considering buying call options on Deeg shares instead of the shares itself. These options expire in three months time and have an exercise price of R210. The call options are currently selling at R40 each.

(a) How shares can you buy?

(b) How many options can you buy?

(c) Calculate the three month rate of return on both strategies assuming that at the option expiration date the
Deeg share price has (1) increased to R265 or (2) decreased to R185.

(d) At what share price level will the person who sells you the Deeg call option break even? Calculate the maximum loss that the call option seller may suffer, assuming that he does not already own Deeg stock.

(e) Discuss the fundamental distinction between a futures contract and an option on a futures contract.

(f) Explain why you agree/disagree with the following statement. 'If two bonds have the same duration, then the
percentage change in the price of the two bonds will be the same for a given change in interest rates.'

Solution Preview

You are a portfolio manager and you are of the opinion that Deeg Inc. shares will rise from its current levels of R200. You are seriously considering purchasing some of these shares. You currently have R400 000 to invest. You are also considering buying call options on Deeg shares instead of the shares itself. These options expire in three months time and have an exercise price of R210. The call options are currently selling at R40 each.

(a) How shares can you buy?

Total investment available = R400,000
Share price = R200
No of shares we can buy = Total investment available / Share price
=400000/200=2000

(b) How many options can you buy?

Total investment available = R400,000
Premium for one option = R40
No of options we can buy = Total investment available / option premium
=400000/40 = 10000

(c) Calculate the three month rate of return on both strategies assuming that at the option expiration date the Deeg share price has (1) increased to R265 or

For Stock Investment ...

Solution Summary

The solution provides the calculation of investment in shares and options.

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