Question
1. A trader spotted the following opportunity: A European listed call and put options pair on the same stock are currently selling for $20 and
1.
A trader spotted the following opportunity: A European listed call and put options pair on the same stock are currently selling for $20 and $9 respectively. Both options have the same strike price of $100 and an expiration in 4 months. With T- bill rate currently at 8.5% per annum (continuously compounded), and banks offering a fixed rate of 12% per annum (continuously compounded). Outline the procedure for a trader to exploit any arbitrage opportunity that is present if the current stock price is $110.
2.
A bank had sold a swap to its client where the bank agreed to pay 7.5% per year and in return, will receive 3-month LIBOR (London Interbank Offer Rate) from its client on a notional principal of $200 million. The swap arrangement will last for another 14 months with payments being exchanged every three months. Current fixed market interest rates being swapped for LIBOR is at 9% per annum for all maturities, continuously compounded. The three-month LIBOR rate one months ago was 9.3% per annum. What is the value of the swap to the bank?
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