Answer the questions below in light of what you know about options.
a. You are a mutual fund manager at the Happy Fund. You will receive a bonus of $10,000, for each percentage by which Happy Fund’s return exceeds that of the S&P 500. If Happy Fund does worse than the S&P 500 you receive no bonus. As the manager of the fund, how can you increase the value of this bonus provision without necessarily working harder?
b. The Toro snowblower dealer offers the following deal. If it does not snow more than 10 inches this winter, customers can return the snowblower for a full refund. Suppose you work at Toro and your job is to decide how to price snowblowers given this type of deal. Briefly explain how you would figure out how much to add to the price to cover the refund policy?
c. You want to buy a new home with a current price of $400,000. You tell the builder you won’t buy now because you are worried that the home price will fall during the next year. The builder offers you the following deal. You will pay $410,000 for the house instead of $400,000. In one year, the home will be appraised by an independent appraiser. If the value falls below $400,000 he will pay the difference between $400,000 and the appraised value. How would you decide whether this is a good deal or not?


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