Question
John wishes to buy a European put option on ABC, Inc., a non-dividend-paying common stock, with a strike price of $50 and six months until
John wishes to buy a European put option on ABC, Inc., a non-dividend-paying common stock, with a strike price of $50 and six months until expiration. ABCs common stock is currently selling for $40 per share, and Tom expects that the stock price will either rise to $70 or fall to $25 in six months. The risk-free rate over the next six months is 2.47% (over next one year is 5%). How do you create a replicating portfolio with identical payoffs to the put option just described?
A) Short .56 of a share of stock and lend $38.89
B) Short 1.80 of a share of stock and lend $37.95
C) Short .56 of a share of stock and lend $37.95
D) Buy .56 of a share of stock and borrow $37.95
E) Buy 1.80 of a share of stock and borrow $38.89
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started