Determine two to three (2-3) methods of using stocks and options to create a risk-free hedge portfolio can be created. Support your answer with examples of these methods being used to create a risk-free hedge portfolio.
- * From the scenario, create a unique hypothetical weighted average cost of capital (WACC) and rate of return. Recommend whether or not the company should expand, and defend your position.
Peer REsponse
Determine two to three (2-3) methods of using stocks and options to create a risk-free hedge portfolio can be created. Support your answer with examples of these methods being used to create a risk-free hedge portfolio.
Hedging is a transaction that lowers a firm’s risk of damage due to fluctuating commodity prices, interest rates, and exchange rates (Brigham, 2014). Hedging, whether in your portfolio, your business or anywhere else is about decreasing or transferring risk. It is a valid strategy that can help protect your portfolio, home and business from uncertainty.
One method of using stocks and options to create a risk-free hedge portfolio is through call options. A call option is an agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument at a specified price within a specific time period. It may help you to remember that a call option gives you the right to “call in” (buy) an asset. You profit on a call when the underlying asset increases in price. Call options offer investors a way to leverage their capital for greater investment returns. For a better understanding please click the link below that shows an animated clip of this process:
http://www.investopedia.com/video/play/call-option/
Another method of using stocks and options to create a risk-free hedge portfolio is through put options. A put option is an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. This is the opposite of a call option, which gives the holder the right to buy shares. A put becomes more valuable as the price of the underlying stock depreciates relative to the strike price. Put option allow investors to hedge an investment they own or speculate in an investment they don’t own. For a better understanding please click the link below that shows an animated clip of this process:
http://www.investopedia.com/video/play/put-option/
Brigham, E. F., & Ehrhardt, M. C. (2014). Financial management (14th ed.). Mason, OH: South-Western Cengage Learning.
