Question
Question 1 (10 Marks) XYZ shares are currently trading at $23. There are two options written on XYZ shares available in the market with the
Question 1 (10 Marks)
XYZ shares are currently trading at $23. There are two options written on XYZ shares available in the market with the same strike of $24 and maturity of 18 months. Information regarding these two options is as follows:
Call options trading at $3.32. You calculate the fair price of this call option is $3.68.
Put options trading at $3.20. You calculate the fair price of this put option is $2.94.
The risk-free rate is 5% compounded continuously.
Prove that an arbitrage opportunity exists using put and call parity. (5 Marks)
Describe a trading strategy to exploit the above arbitrage opportunity. The table below may be useful. (5 Marks)
|
Strategy |
Cost | PAYOFF | |
| ST > X | ST < X | ||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Net cost/payoff |
|
|
|
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
Principles Of Auditing And Other Assurance Services
Authors: Ray Whittington, Kurt Pany
21st Edition
978-1259916984
