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Hector Francisco is a successful businessman in Atlanta. The
box-manufacturing firm he and his wife, Judy, founded several years
ago has prospered. Because he is self-employed, Hector is building
his own retirement fund. So far, he has accumulated a substantial
sum in his investment account, mostly by following an aggressive
investment posture. He does this because, as he puts it, “In this
business, you never know when the bottom’s gonna fall out.” Hector
has been following the stock of Rembrandt Paper Products (RPP), and
after conducting extensive analysis, he feels the stock is about
ready to move. Specifically, he believes that within the next 6
months, RPP could go to about $80 per share, from its current level
of $57.50. The stock pays annual dividends of $2.40 per share.
Hector figures he would receive two quarterly dividend payments
over his 6-month investment horizon. In studying RPP, Hector has
learned that the company has 6-month call options (with $50 and $60
strike prices) listed on the CBOE. The CBOE calls are quoted at $8
for the options with $50 strike prices and at $5 for the $60
options.
Questions
a. How many alternative investment vehicles does Hector have if
he wants to invest in RPP for no more than 6 months? What if he has
a 2-year investment horizon?
b. Using a 6-month holding period and assuming the stock does
indeed rise to $80 over this time frame: 1. Find the value of both
calls, given that at the end of the holding period neither contains
any investment premium.
2. Determine the holding period return for each of the 3
investment alternatives open to Hector Francisco.
c. Which course of action would you recommend if Hector simply
wants to maximize profit? Would your answer change if other factors
(e.g., comparative risk exposure) were considered along with
return? Explain
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The post Determine the holding period return for each of the 3 investment alternatives open to Hector Francisco. appeared first on Wise Papers.
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