Consider a model with two nondividend-paying stocks, Stock 1 and Stock 2, and a special 5-year European

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Consider a model with two nondividend-paying stocks, Stock 1 and Stock 2, and a special 5-year European straddle on Stock 1, with a strike price given by the 5-year price of Stock 2.

You are given:

(i) The current prices of Stock 1 and Stock 2 are both 60.

(ii) Stock 1’s volatility is 40%.

(iii) Stock 2’s volatility is 50%.

(iv) The continuously compounded risk-free interest rate is 6%.

(v) The current price of the straddle is 72.

Calculate the correlation coefficient between the continuously compounded returns of the two stocks.

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