Maverick Manufacturing, Inc., must purchase gold in three months for use in its
ID: 2740419 • 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 $1,595 per ounce, the firm would go bankrupt. The current price of gold is $1,515 per ounce. The firm’s chief financial officer believes that the price of gold will either rise to $1,735 per ounce or fall to $1,405 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 6.0 percent.
What strike price would the company like this option to have? (Do not round intermediate calculations.)
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))
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))
c1: buy/sell
c2: lend /borrow
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))
$
a-1. Should the company buy a call option or a put option on gold? Put option Call optionExplanation / Answer
A.)
1. Yes it should go for a call option, incase price rises to 1595 in future firm will go bankrupt.we have considered
1571.08
buying per ounce of call as safe play. so that overall cost outgo on account of interest and cash is not exceeding 1595. So, that company tied over this uncertainity and not affect cash outgo on account of unprecedented increase of gold prices beyond threshold limit.
A.) 2.
1571.08 should be the strike price including the premium.
A) 2.) b) 56.08 including premium payable on purchase of the call option. Should not increase beyond 1571.08.
C.) Lend higher amount and borrow less amount so that, interest received is more than the interest paid on the whole transaction. Other option is buy the put option with strike price 1505.
D.) It will depend upon the company that at this time they are ready for going to long call or short buy position this will depend upon the forecast as presented by CFO and company beliefs of the forecast in the direction of upmovement or downmovement.
But, if it goes for short option as seen so that maximum loss it can get is seen will be restricted to the extent of put option. But, it will buy call option @ less than 1595 as it may get bankrupt as per the company forecast so, same should be made to understand. So alternatively, if it goes for the buying put option it can get 1426.08 with interest on option 21.08.
1571.08 should be the strike price including the premium.
A) 2.) b) 56.08 including premium payable on purchase of the call option. Should not increase beyond 1571.08.