Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

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

image text in transcribed
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 2 53 3 54 4 54 5 52 6 54 Table 4. 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 2 53 3 54 4 54 5 52 6 54 Table 4. 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)

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

International Finance

Authors: Keith Pilbeam

5th Edition

1350347094, 978-1350347090

More Books

Students also viewed these Finance questions

Question

What is the orientation toward time?

Answered: 1 week ago

Question

4. How is culture a contested site?

Answered: 1 week ago