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Consider a stock priced at $30. There are put and call options available at exercise prices of 30 and a time to expiration of six months. The calls are priced at $2.89 and the puts cost $2.15. There are no dividends on the stock and the options are European. Assume that all transactions consist of 100 shares or one contract (100 options). Use this information to answer the following questions.

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Suppose you think Apple stock is going to appreciate substantially in value in the next year. Say the stock’s current price, S0, is $100, and the call option expiring in one year has an exercise price, X, of $100 and is selling at a price, C, of $10. With $10,000 to invest, you are considering three alternatives:

a. Invest all $10,000 in the stock, buying 100 shares.

b. Invest all $10,000 in 1,000 options (10 contracts).

c. Buy 100 options (one contract) for $1,000 and invest the remaining $9,000 in a money market fund paying 4% interest annually.


a. Calculate the value of the investment for stock price one year from now? (Leave no cells blank - be certain to enter "0" wherever required.)

The Prices are $80, $100, $110, $120

All stocks(100 shares)

All Options (1000 Shares)

Bills + 100 options

b. Calculate the rate of return on investment for stock price one year from now? (Leave no cells blank - be certain to enter "0" wherever required. Negative values should be indicated by a minus sign. Round your answers to 1 decimal place.)

The Prices are $80, $100, $110, $120

All stocks(100 shares)

All Options (1000 Shares)

Bills + 100 options

As a newly minted MBA, you've taken a management position withExotic Cuisines, Inc., a restaurant chain that just went publiclast year. The company's restaurants specialize in exotic maindishes, using ingrediants such as alligator, buffalo, and ostrich.A concern you had going in was that the restaurant business is veryrisky. However, after some due diligence, you discovered a commonmisperception about the restaturant industry. It is widely thoughtthat 90 percent of new restaurants close within three years;however, recent evidence suggests the failure rate is 60 percentover three years. So it is a risky business, althought not as riskyas you originally thought.

During your interview process, one of the benefits mentioned wasemployee stock options. Upon signing your employment contract, youreceived options with a strik price of $50 for 100,000 shares ofcompany stock. As is fairly common, your stock options have athree-year vesting period and a 10-yaer expiration, meaning thatyou cannot exercise the options for three years, and you lose themif you leave before thy vest. After the three-year vesting period,you can exercise the options at any time. Thus, the employee stockoptions are European (and subject to forfeit) for the first threeyears and American afterward. Of course, you cannot sell theoptions, nor can you enter into any sort of hedging agreement. Ifyou leave the company after the options vest, you must exercisewithin 90 days or forfeit.

Exotic Cuisines stock is currently trading at $38.15 per share,a slight increase from the initial offering price last year. Thereare no market-traded options on the company's stock. Because thecompany has been traded for only about a year, you are reluctant touse the historical returns to estimate the standard deviation ofthe stock's return. However, you have estimated that the averageannual standard deviation for restaurant company stocks is about 55percent. Because Exotic Cuisines is a newer restaurant chain, youdecide to use a 60 percent standard deviation in your calculations.The company is relatively young, and you expect that all earningswill be reinvested back into the company for the near future.Therefore, you expect no dividends will be paid for at least thenext 10 years. A three-year Treasury note currently has a yield of3.8 percent, and a 10-year Treasury note has a yield of 4.4.percent.

2. Suppose that in three years the company's stock is trading at$60. At that time, should you keep the options or exercise themimmediately? What are some of the important determinants in makingsuch a decision?

3. Your options, like most employee stock options, are nottransferable or tradable. Does this have a significant effect onthe value of the options? Why?

The stockholders’ equity section of Nash Inc. at the beginning of the current year appears below. Common stock, $10 par value, authorized 1,066,000 shares, 319,000 shares issued and outstanding $3,190,000 Paid-in capital in excess of par—common stock 569,000 Retained earnings 552,000 During the current year, the following transactions occurred. 1. The company issued to the stockholders 98,000 rights. Ten rights are needed to buy one share of stock at $31. The rights were void after 30 days. The market price of the stock at this time was $33 per share. 2. The company sold to the public a $188,000, 10% bond issue at 103. The company also issued with each $100 bond one detachable stock purchase warrant, which provided for the purchase of common stock at $29 per share. Shortly after issuance, similar bonds without warrants were selling at 96 and the warrants at $7. 3. All but 4,900 of the rights issued in (1) were exercised in 30 days. 4. At the end of the year, 80% of the warrants in (2) had been exercised, and the remaining were outstanding and in good standing. 5. During the current year, the company granted stock options for 10,100 shares of common stock to company executives. The company, using a fair value option-pricing model, determines that each option is worth $10. The option price is $29. The options were to expire at year-end and were considered compensation for the current year. 6. All but 1,010 shares related to the stock-option plan were exercised by year-end. The expiration resulted because one of the executives failed to fulfill an obligation related to the employment contract. Prepare general journal entries for the current year to record the transactions listed above. Prepare the stockholders’ equity section of the balance sheet at the end of the current year. Assume that retained earnings at the end of the current year is $775,000

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