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ROA/ROE, butterfly spread , option strategy

1. Firm A and Firm B have the same ROA, yet firm A's ROE is higher. How can you explain this?

2. A butterfly spread is the purchase of one call at exercise X1, the sale of two calls at exercise price X2, and the purchase of one call at exercise X3. Assume that X1 = 20, X2 = 25, and X3 = 30. Graph the payoff structure to this strategy. Under what circumstance does this strategy make the most money?

3. You write a call option with X = 50 and buy a call option with x = 60. The options are on the same stock and have the same maturity date. One of the calls sells for $3 and the other for $9.
a. Draw the payoff graph for this strategy at the option maturity date.
b. Draw the profit graph for this strategy.
c. What is the break-even point for this strategy? Is the investor bullish or bearish on the stock?

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Solution Summary

The solution
1) Explains how two firms can have same ROA, yet different ROE.
2) Graphs the payoff of a butterfly spread
3) Draws the payoff of an option strategy of writing a call option with X = 50 and buying a call option with X = 60.

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