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a. The price of a share of stock is RM55. The stock pays dividends at a continuously compounded rate of 5%. The stock volatility is
a. The price of a share of stock is RM55. The stock pays dividends at a continuously compounded rate of 5%. The stock volatility is being estimated using the past 6 weeks of the closing price of stock in table 4. The price evolution of the stock follows the binomial pricing model with each period being 6 months in length. Week Price (RM) 1 50 53 54 54 52 6 54 Table 4. OWN The continuously compounded risk-free rate is 8%. Three European put options on the stock with their market prices are listed in table 5 below: Strike Price Market Put Value (RM) (RM) 50 1.60 55 4.70 60 8.90 Table 5. An arbitrageur constructs arbitrage profits from the above table 5. Given that X is the arbitrage strategy profit involving the purchase or sale of exactly 50 of the at the money European put options and Y is the arbitrage profit involving the purchase or sale of exactly 100 out of the money European put options. Demonstrate the arbitrage strategy and determine Y-X. (17 marks) a. The price of a share of stock is RM55. The stock pays dividends at a continuously compounded rate of 5%. The stock volatility is being estimated using the past 6 weeks of the closing price of stock in table 4. The price evolution of the stock follows the binomial pricing model with each period being 6 months in length. Week Price (RM) 1 50 53 54 54 52 6 54 Table 4. OWN The continuously compounded risk-free rate is 8%. Three European put options on the stock with their market prices are listed in table 5 below: Strike Price Market Put Value (RM) (RM) 50 1.60 55 4.70 60 8.90 Table 5. An arbitrageur constructs arbitrage profits from the above table 5. Given that X is the arbitrage strategy profit involving the purchase or sale of exactly 50 of the at the money European put options and Y is the arbitrage profit involving the purchase or sale of exactly 100 out of the money European put options. Demonstrate the arbitrage strategy and determine Y-X. (17 marks)
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