8.7. Consider the transaction: {buy 800 units of the traded asset, sell the option to invest, borrow

Question:

(or short bills) at 10%} This results in the following payoffs:

Year 1 Now FCF = $100 FCF = $200 Buy 800 units ($1,090.91) 800.00 1,600.00 Sell the call 400.00 0 (800.00)

(690.91)

Borrow @ 10% 727.27 (800.00) (800.00)

Arbitrage profit $36.36 0 0 The arbitrage profit is the difference between the value of the option calculated in problem

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