Question 1 () We spent a couple of weeks studying forwards and futures contracts. For these derivatives, there are no cashflows on the origination of the contract. 1 Options are very different. As we will see, they offer you greater flexibility than forwards/futures. As such, you do have to pay money to enter them (this is called the option premium). The person who enters the long option position pays the premium and the seller/writer of the option receives that same premium. In each of the following cases, we identify: • whether we pay or receive the option premium, • the decision rule (for what range of share prices will the option be exercised?), • the resulting cashflows (if the option is in-the-money). Although one option contract typically covers 100 shares, we report numbers on a per share basis, then multiply by 100 shares at the end. a) We take a long call position, hence we pay the premium of $2.30 per share on 100 shares. This gives us the
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