course material

1. The purpose of the Final Cases is for you to culminate the learning
achieved in the course by describing your understanding and application
of knowledge in the field of financial investment management.
Complete and submit to your instructor Case 14.1: Alternative investment options 9 (pages
613-614) and Case 15.2: Hedging with Stock-index futures (pages 647-648). Instructions
are as follows:The final cases should demonstrate understanding of the reading as well as
the implications of new knowledge. The 15 to 20 page paper covering both cases should
integrate readings and class discussions into work and life experiences. It may include
explanation and examples from previous experiences as well as implications for future
applications.The purpose of the Final Cases is for you to culminate the learning achieved in
the course by describing your understanding and application of knowledge in the field of
financial investment management.Use formulas to calculate the answers to mathematical
sections and round to the nearest whole number. Clearly label the analysis.Case Problem
14.1 The Franciscos’ Investment Options CASE 1Hector Francisco is a successful
businessman in Atlanta. The box-manufacturing firm he and his wife, Judy, founded several
years ago has prospered. Because he is self-employed, Hector is building his own retirement
fund. So far, he has accumulated a substantial sum in his investment account, mostly by
following an aggressive investment posture. He does this because, as he puts it, “ In this
business, you never know when the bottom’ s gonna fall out.” Hector has been following
the stock of Rembrandt Paper Products (RPP), and after conducting extensive analysis, he
feels the stock is about ready to move. Specifically, he believes that within the next 6
months, RPP could go to about $80 per share, from its current level of $57.50. The stock
pays annual dividends of $2.40 per share. Hector figures he would receive two quarterly
dividend payments over his 6-month investment horizon. In studying RPP, Hector has
learned that the company has 6-month call options (with $50 and $60 strike prices) listed
on the CBOE. The CBOE calls are quoted at $8 for the options with $50 strike prices and at
$5 for the $60 options.Questionsa.How many alternative investment vehicles does Hector
have if he wants to invest in RPP for no more than 6 months? What if he has a 2-year
investment horizon?b.Using a 6-month holding period and assuming the stock does indeed
rise to $80 over this time frame:1. Find the value of both calls, given that at the end of the
holding period neither contains any investment premium.2. Determine the holding period
return for each of the 3 investment alternatives open to Hector Francisco.c.Which course of

2. action would you recommend if Hector simply wants to maximize profit? Would your
answer change if other factors (e.g., comparative risk exposure) were considered along with
return? Explain.CASE 2Case Problem 15.2 Jim and Polly Pernelli Try Hedging with Stock-
Index FuturesJim Pernelli and his wife, Polly, live in Augusta, Georgia. Like many young
couples, the Pernellis are a 2-income family. Jim and Polly are both college graduates and
hold high-paying jobs. Jim has been an avid investor in the stock market for a number of
years and over time has built up a portfolio that is currently worth nearly $375,000. The
Pernellis’ portfolio is well diversified, although it is heavily weighted in high-quality, mid-
cap growth stocks. The Pernellis reinvest all dividends and regularly aID investment capital
to their portfolio. Up to now, they have avoided short selling and do only a modest amount
of margin trading.Their portfolio has undergone a substantial amount of capital
appreciation in the last 18 months or so, and Jim is eager to protect the profit they have
earned. And that’ s the problem: Jim feels the market has pretty much run its course and is
about to enter a period of decline. He has studied the market and economic news very
carefully and does not believe the retreat will cover an especially long period of time. He
feels fairly certain, however, that most, if not all, of the stocks in his portfolio will be
adversely affected by these market conditions—
though some will drop more in price than
others.Jim has been following stock-index futures for some time and believes he knows the
ins and outs of these securities pretty well. After careful deliberation, Jim and Polly decide
to use stock-index futures—
in particular, the S&P MidCap 400 futures contract—
as a way to
protect (hedge) their portfolio of common stocks.Questionsa.Explain why the Pernellis
would want to use stock-index futures to hedge their stock portfolio, and how they would
go about setting up such a hedge. Be specific.1. What alternatives do Jim and Polly have to
protect the capital value of their portfolio?2. What are the benefits and risks of using stock-
index futures as hedging vehicles?b.Assume that S&P MidCap 400 futures contracts are
currently being quoted at 769.40. How many contracts would the Pernellis have to buy (or
sell) to set up the hedge?1. Say the value of the Pernelli portfolio dropped 12% over the
course of the market retreat. To what price must the stock-index futures contract move in
order to cover that loss?2. Given that a $16,875 margin deposit is required to buy or sell a
single S&P 400 futures contract, what would be the Pernellis’ return on invested capital if
the price of the futures contract changed by the amount computed in part b1,
above?c.Assume that the value of the Pernelli portfolio declined by $52,000, while the price
of an S&P 400 futures contract moved from 769.40 to 691.40. (Assume that Jim and Polly
short sold one futures contract to set up the hedge.) 1. AID the profit from the hedge
transaction to the new (depreciated) value of the stock portfolio. How does this amount
compare to the $375,000 portfolio that existed just before the market started its retreat?2.
Why did the stock-index futures hedge fail to give complete protection to the Pernelli
portfolio? Is it possible to obtain perfect (dollar-for-dollar) protection from these types of
hedges? Explain.d.What if, instead of hedging with futures contracts, the Pernellis decide to
set up the hedge by using futures options? Fortunately, such options are available on the
S&P MidCap 400 Index. These futures options, like their underlying futures contracts, are
also valued/priced at $500 times the underlying S&P 400 Index. Now, suppose a put on the
S&P MidCap 400 futures contract (with a strike price of 769) is currently quoted at 5.80,

3. and a comparable call is quoted at 2.35. Use the same portfolio and futures price conditions
as set out in part c to determine how well the portfolio would be protected if these futures
options were used as the hedge vehicle. (Hint: AID the net profit from the hedge to the new
depreciated value of the stock portfolio.) What are the advantages and disadvantages of
using futures options, rather than the stock-index futures contract itself, to hedge a stock
portfolio?Must be 15- to 20- double-spaced pages in length and formatted according to APA
style as outlined in the approved APA style guide.Must include a cover page that
includes:Student’ s nameCourse name and numberTitle of paperInstructor’ s nameDate
submittedMust include an introductory paragraph with a succinct thesis statement.Must
aIDress the topic of the paper with critical thought.Must conclude with a restatement of the
thesis and a conclusion paragraph.Must use at least five professional resources, including a
minimum of two from ProQuest.Must use APA style as outlined in the approved APA style
guide to document all sources.Must include, on the final page, a Reference Page that is
completed according to APA style as outlined in the approved APA style guide.