CFA Practice Question

There are 206 practice questions for this study session.

CFA Practice Question

Continue with question 1. Assume a stock price is $55 and that in the next year it will either rise by 20% or fall by 16%. The risk-free interest rate is 5%. A call option on this stock has an exercise price of $60. What would you hold to form a risk-free portfolio if the call option is selling for $3.33?

I. Sell 1000 shares of this stock and buy 303 call options.
II. Buy 1000 shares of this stock and sell 303 call options.
III. Sell 1000 call options and buy 303 shares.
IV. Buy 1000 call options and sell 303 shares.
Correct Answer: III and IV

n = (c+ - c-) / (S+ - S-) = (6 - 0) / (66 - 46.2) = 0.3030

For every option sold (bought), we should purchase (sell) 0.303 shares of stock. The hedge portfolio will yield a risk-free rate of return.

User Contributed Comments 4

User Comment
danlan2 II: EMF
mazen1967 note that the price of the optin is exactly c0
so we may either buy or sell the option and take the opposite regarding the asset
tim2 Seems to me none of them are risk free.

Take III for example sell 1000 calls, buy 303 shares.
Selling the calls get you 3.33*1000= $3,330
Buying the shares costs 303*55 = $16,665
If the share go to zero, the calls are worthless and you are out of pocket 3,300-16,665 = $13,335

Not risk free! Where am I going wrong?
hocj Calculations are based on assumptions that price will either rise by 20% or fall by 16%.
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