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Part (1) (4 marks) Draw a payoff structure for a short call option with a strike price of $20. Clearly label the axis and the
Part (1) (4 marks) Draw a payoff structure for a short call option with a strike price of $20. Clearly label the axis and the strike price. Part (2) (5 marks) Suppose that 180-day USD-sterling forward exchange rate is $1.56/. What opportunity is open to an arbitrageur if a 180-day European call option to buy 1 for $1.52 costs 2 cents? Assume zero interest rate. In your answer, please clearly describe the positions (i.e. long/short) to be taken by the arbitrageur in the forward and the call option. You should also explain how the strategy can help to generate an arbitrage profit. (Hint: determine the payoff of the forward and option if the option ends up in-the-money and/or out-of-the-money)
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