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Various hedging strategies including a bull spread, a butterfly spread, and a ratio spread.

Your firm has a well-respected economic research staff. The staff members have been successful in developing econometric models that can predict macroeconomic variables with a surprisingly degree of accuracy. The economic research staff would like to know which variables to monitor if options are ultimately used by the firm. Write a 2-3 page document to Mr. Curtis explaining how the listed variables impact the prices of call options and what the associated theory is behind each relationship:

1.stock price
2.risk-free rate
3.exercise price
4.stock volatility

It is also important to recognize if put-call parity conditions are being met; if not, an arbitrage opportunity exists for the firm. In the following situation, identify whether or not an arbitrage opportunity exists if the:
call price = $1.15.
exercise price = $22.50.
time to expiration = 60 days.
put price = $0.55.
annual interest rate = 12%.
the stock pays zero dividends.

Mr. Curtis and Mrs. Kesich think that option strategies need to be developed due to future foreign currency transactions that will occur when their contract with an Italian high-tech firm is finalized. They first need you to construct a memo of 5 paragraphs in length on various hedging strategies including a bull spread, a butterfly spread, and a ratio spread.

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A. Your firm has a well-respected economic research staff. The staff members have been successful in developing econometric models that can predict macroeconomic variables with a surprisingly degree of accuracy. The economic research staff would like to know which variables to monitor if options are ultimately used by the firm. Write a 2-3 page document to Mr. Curtis explaining how the listed variables impact the prices of call options and what the associated theory is behind each relationship:

1.Stock price
• Stock price plays an important role when deciding to buy a call option.
• If you think the stock price at the time of expiration (St) will be greater than the strike price (K) provided, you should definitely buy the call option to reap the profit of the increase in stock price.
• “Bullish” stock price is a good sign to buy a call option, you also have to consider the cost of the option. If the option is priced at the reasonable cost and if you think that the future stock price (St) will exceed (K + call option cost)
• If you think the stock is going “bearish”, you should short or sell the call options. You will then make money if they stock price is going down because you will collect the call option fee since investors are not going to exercise their option.
St>K St<K K = exercise price St= stock price
ABC STOCK Call Option St-K 0 St>K = in the money
Zero coupon bond K K St<K = out of the money
Total St K St=K= at the money

2. Risk-free rate
• Risk free rate is also another thing that you have to consider.
• If the interest free rate is pretty high, instead of using your ...

Solution Summary

This solution provides calculations, explanation and graphs for the following investment strategies in 1129 words.

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