Problem 14-10

The common stock of Company XLT and its derivative securities currently trade in the market at the following prices and contract terms:

	Price ($)		Exercise Price ($)
Stock XLT	26.00		-
Call option on Stock XLT	5.80		25.00
Put option on Stock XLT	4.30		25.00

Both of these options will expire 91 days from now, and the annualized yield for the 91-day Treasury bill is 5.0%. (Assume face value is $100.)

1. How to construct a synthetic Treasury bill position?

   The transactions needed to construct the synthetic T-Bill would be to -Select-longshortItem 1 the stock, -Select-longshortItem 2 the put and -Select-longshortItem 3 the call.

2. Calculate the annualized yield for the synthetic Treasury bill in Part a using the market price data provided and a simple interest approach. Do not round intermediate calculations. Round your answer to two decimal places.

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3. Describe the arbitrage strategy implied by the difference in yields for the actual and synthetic T-bill positions. Show the net, riskless cash flow you could generate assuming a transaction involving 25 actual T-bills and 100 synthetic T-bills. Do not round intermediate calculations. Round your answer to the nearest cent.

   The strategy would be to -Select-longshortItem 5 25 actual T-bills and to -Select-longshortItem 6 100 synthetic T-bills.

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4. What is the net cash flow of this arbitrage strategy at the option expiration date, assuming that Stock XLT trades at $27 at expiration three months from now? Do not round intermediate calculations. Round your answer to the nearest cent. If your answer is zero, enter 0.

   $