Finance Assignment-Corporate Finance

Corporate Finance

1) We discussed calls in class. A call is a financial instrument that allows the owner of the call to buy a stock at a certain price. i.e.., if google is selling for $100/share. And I own a call for $105. That means i have the right to buy google at $105 from the institution that sold me the call. Today, I would not use my right to buy at $105, because it would be cheaper to simply by Google at $100 (the current market price). However, if the market price of google goes to $110, i could, and probably would use my right to buy at 105, sell at 110 and pocket the difference. This type of instrument is called an ‘option’ as I, the owner, have the option to use or not use my right of ownership. Based on the price. Let’s use the simple risk model we discussed in class. I.e., there is a 50/50 chance of one of two outcomes happening. Specifically, there is a 50% chance Google will go to $110, and a 50% chance it will go to $90.
 

1. a) How much would you expect the call option to sell for?

 

105. b) If over time the price of google went to 105. And there was 50/50 chance of price going in the future to 95 or 115, how much would you expect your call option (at 105) to sell for?

 

110. c) If over time the price of google went to 110. And there was 50/50 chance of price going in the future to 100 or 120, how much would you expect your call option (at 105) to sell for?

 

1. d) If google is currently selling for $100, and you owned a call at 105, and the market price of your option went up over time, how would you interpret that increase?

 
 
2) Why do sometimes investors and management have disagreements on how much risk to take on when thinking of investments?
 
 
 
3) Why is capital investment sometimes seen as voting with your feet? ie, indicating confidence in the future of the business?
 
 
 
4) Typically, home mortgages are 30 year loans. The overwhelming percentage of mortgages get paid off well before 30 years. On average, mortgage loans get repaid in 3-7 years. Why is there a difference between the 30 year term, and the 3-7 average? What would happen if banks did away with thirty year mortgages and made all mortgages just 3 years?