An individual entire wealth is from one stock. The current value of the stock is $55, and the individual owns one million shares. This individual purchased puts on the stock with an exercise price of $52 to protect his wealth. He bought enough puts to protect his entire holdings of this stock. The expiration of the put is 4 years. Immediately after buying the puts he was appointed to a 4-year government position and was told that if want to stay in the government position his return over the next two years must exactly equal the risk-free rate. The risk-free rate is 10%. You have been asked to construct a spread that will provide the investor with a return over the next two years that exactly equals the return from the risk-free return on his stock holdings. You can only buy the minimum number of needed derivatives given the investors current holdings. A speculator is willing to sell or buy from you any option with any strike price with a two- year exercise.

Assume that the stock does not pay dividends.

Part a.

What are the arbitrage possibilities for the stock in Part 4 of this assignment when p = 3.25?

Part b.

What are the arbitrage possibilities for the stock in Part 4 of this assignment when p = 1?