14. Consider two strategies:

Strategy 1: Purchase one unit of Asset M currently selling for $103. A distribution of $10 is expected one year from now.

Strategy 2:

(a) Purchase a call option on Asset M with an expiration date one year from now and a strike price of $100; and

(b) place sufficient funds in a 10% interest-bearing bank account to exercise the option at expiration

($100) and to pay the cash distribution that would be paid by Asset M ($10).

a. What is the investment required under Strategy 2?

b. Give the payoffs of Strategy 1 and Strategy 2, assuming that the price of Asset M one year from now is

(i) $120,

(ii) $103,

(iii) $100,

(iv) $80.

c. For the four prices of Asset M one year from now listed in part (b), demonstrate that the following relationship holds: Call option price ≥ Max

[0, (Price of underlying asset − Present value of strike price − resent value of cash distribution)].