Question

Consider the Fama-French 3-factor model. The risk-free rate is 1% and the xpected return on the market is 11%. The stock's market beta is 1, SMB beta is 0.5 and eta is -0.5. EPML) and Ers) are 6% and 7%, respectively. The stock's expected return is 12%. Relative to the Fama-French 3-factor model, the stock has and is 1) Positive alpha, undervalued 2) Positive alpha, overvalued 3) Negative alpha, undervalued 4) Negative alpha, overvalued 5) Zero alpha, Fairly valued A call option with a strike price of $50 on a stock selling at 60 costs $12.5. The call option's intrinsic value is and time value is 1) 10, 12.5 2) 12.5, 10 3) 50, 12.5 4) 10, 2.5 5) None of the above

Answer 1

7 Accoding to Fama - French 3 Factor Model- Required Return= Risk Free Rate+ Bita of stock( Market Return-Risk Free Rate)+SBM Beta*E(r SBM)+HML Beta(E(THML) Required return=1+1*(11-1)+0.5*(7)+-0.5*(6) Required Returns 10.50% Alpha= Expected Return-Required Return = 12-10.5 1.50% So, the stock has Positive alpha Undervalued 8 Intersic Value: Is the diffrence between the underlying market price and strike price of the option to the extent that this is in favor of the option holder For Call option, Intersic Value is= Max(0, S-K) K= Strike Price = 60-50 S=Spot price IV= 10 II) Time Value is the amount of option trader is paying for a contract above its intersiv value with the belief that priot to expiration the contract value will increase because of a favourable change in the price of the underlying assets Time Values Option Premium - Intersic value = 12.5-10 Time value 2.5