A portfolio consists of 400 shares of stock and 200 calls on that stock. If the hedge ratio for the call is 0.6, what would be the dollar change in the value of the portfolio in response to a $1 decline in the stock price?
A) +$700
B) +$500
C) −$580
D) −$520

Question

Quizplus · Accepted Answer

The hedge ratio of 0.6 means each call option changes in value by $0.60 for every $1 change in the stock price. With 200 calls, the total change in value from the calls is 200 * 0.6 = $120. The 400 shares will decrease in value by 400 * $1 = $400. Therefore, the total change in the portfolio value is -$400 (from shares) + $120 (from calls) = -$280. However, the correct calculation should be -$400 (from shares) - $120 (from calls) = -$520, as the calls also lose value when the stock price declines.

A Portfolio Consists of 400 Shares of Stock and 200