1. The European put option on Summer.com with an exercise price of $50 expiring a year from now isselling for $10.60, and the risk free rate is 4%. Suppose that you would like to establish a long position in aone-year European call option written on the stock with a strike price of $50. You could buy the call in theoptions market, where it is currently trading for $7.90. The current stock price is $45. As you are about tosubmit your order, it just occurs to you that in F303 you learned that you could also create the positionsynthetically by using a replicating portfolio. (a) Describe the replicating portfolio by demonstrating that the payoff from your portfolio isidentical to that of the call option no matter what the stock price is on the expiration day a year

from now. Please use a payoff diagram or payoff table to prove your claim. (b) What is the price of the replicating portfolio? Is the call correctly priced relative to thereplicating portfolio? (c) If the call is mispriced in the option market, describe the arbitrage trade you could engage in tocapitalize in on the mispricing.