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19 July, 18:42

3. You have $100 to invest. The price of XYZ stock is $100. You sell short one share of XYZ and then invest all available funds (your initial $100 and any short-sale proceeds) in one-year zero-coupon bonds with 5% yield to maturity. One year later, the price of XYZ is $90. There are no dividends. What is the HPR on your initial $100?

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  1. 19 July, 19:08
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    HPR = holding period Return is 20%

    Explanation:

    Given original Investment = $100 Short sale proceeds for 1 share = $100 Investment made of $100 + short sale proceeds of $100 at 5% YTM. So Maturity Value = Investment x (1+YTM) ^number of years = 200 x (1 + 0.05) ^1 = 210

    Therefore, In order to cover Short sale of 1 share, we will have to buy 1 share at a closing value of $90 As such, holding period Return = (Investment proceeds from ZCB - Buying price of stock - Investment amount) / Investment Amount = (210 - 90 - 100) / 100 = 0.2 or 20%

    Hence, HPR = holding period Return is 20%
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