Question
Consider the following two strategies. Strategy 1: Purchase one unit of asset M, currently selling for $103 . A distribution of $10 is expected one
Consider the following two strategies.
Strategy 1: Purchase one unit of asset M, currently selling for $103 . A distribution of $10 is expected one year from now.
Strategy 2: Purchase a call option on asset M with an expiration date one year from now and a strike price of $100 , and place funds in a 10% interest-bearing bank account sufficient to exercise the option at expiration ( $100 ) and to pay the cash distribution that would be paid by asset M ( $10 ).
Assuming that the price of asset M one year from now is $120 , $103, $100, or $80
For the four prices of asset M one year from now, demonstrate that the following relationship holds:
Call option price > Max [0, (Price of underlying asset Present value of strike price Present value of cash distribution)].
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