Maverick Manufacturing, Inc., must purchase gold in three months for use in its
ID: 2739853 • Letter: M
Question
Maverick Manufacturing, Inc., must purchase gold in three months for use in its operations. Maverick’s management has estimated that if the price of gold were to rise above $1,545 per ounce, the firm would go bankrupt. The current price of gold is $1,465 per ounce. The firm’s chief financial officer believes that the price of gold will either rise to $1,635 per ounce or fall to $1,355 per ounce over the next three months. Management wishes to eliminate any risk of the firm going bankrupt. Maverick can borrow and lend at the risk-free EAR of 8.0 percent.
a-1. Should the company buy a call option or a put option on gold?
Put option or Call option
a-2 What strike price would the company like this option to have? (Do not round intermediate calculations.)
Strike price
b. How much should such an option sell for in the open market? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Option price $
c. Suppose no options currently trade on gold. What are the transactions needed to create a synthetic option with identical payoffs to a traded option? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
c-1. (buy or sell?) $ shares of stock
c-2. (borrow or lend?) Amount to $
d. How much does the synthetic option cost? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Synthetic option $
Explanation / Answer
ans)
Period to Purchase gold 3 months Expected to rise $1545 per ounce Curent Price $1465 per ounce Price of gold will rise $1635per ounce Price of gold will fall $ 1355per hounce Expected price 0.5*1635+0.5*1355 1495$ Risk free EAR 8% a1 Company Should buy a call option(right to buy) since copany want to purchase gold 3 month later a2 The company like this option to have when strike price $1545 per ounce because company expected that , market price Expected to rise above $1545 per ounce in 3months b When price in the market below the market price is 1495$ i.e less than $1545 per ounce then copany can buy in the open market c Currently no options currentliy tading on gold use money market hedge Expected price =1495$ per ounce c-1 current price =1545$ per ounce since Expeced price is decresing than current price so sell the shares of stock immediately c-2 Discount or Premium on price 3.24 Interest for 3 months 8%*3/12 2 % since price traded at Discount led the money at 2% for the months and then purchase at 1495$ per ounce. d Synthetic option cost Purchse cost per ounce 1495 $ Less Interest on lend the money for 3month 29.9 $ Net cost per ounce 1465.1 $