Reference no: EM131923685

Rich Greatuncle Scrooge is a big fan of Goofy's Candy Co. (GOOF), a large publicly traded investment company that does not pay dividends, and wishes to give his grandnephew, Dewey 500 shares of GOOF in exactly one year. Currently GOOF sells for $1000 per share, so the current cost of the shares is $500,000. Huey could buy the shares now, and hold them for one year before giving them to Dewey. The current risk free rate is 3% effective, so Huey could also simply invest the $500,000 at the risk free rate, and purchase shares in one year to give to Dewey. But Huey believes that the share price of GOOF will rise significantly in the next year, so he prefers to purchase the shares now. At the same time he wants to make sure that whatever happens, Dewey will receive no less than what he would have received had he simply invested the money for one year at the risk free rate.

(a) Explain how to construct a portfolio consisting of shares of GOOF and appropriate options that would have the characteristics that Huey desires.

(b) How much would Huey have to pay to construct this portfolio given that currently the cost of a 1 year 1,030 strike put on GOOF is $48.00?

Write down the payoff function for this portfolio. Note that if x and y are numbers, then max{x, y} = x + max{0, y − x}.