This is in booklet 6 question 9. When we are calculating the hedging portfolio of shares and cash to hedge against the CEO's bonus I don't understand why we take into account the value of the options. In a normal scenario this makes sense because there is income generated from selling call options. However in this instance the company has not sold these call options, they have actually given them away, therefore generating no income. So, I thought the hedging portfolio would be long 1.650m shares which would cost £1.485m to purchase and therefore the company would have to borrow £1.485m to fund this purchase. In the solutions the value of the call options has then been subtracted but this does not make sense to me. Can you explain? Thank you
The acquisition of the shares in not an issue here, all that needs to be found is the number shares and the amount of cash that matches the behaviour of the CEO's bonus. The value of the portfolio you've suggested is zero.
