Question 2 a) An investor owns 500 shares of stock A. The current stock price is $40. A three- month put option with a strike price of $36 costs $3. Explain how investor can hedge using the put option, and compare investor's portfolio value with or without hedging three months later in different situations. (15 marks) b) The GBP/USD exchange rate is 1.3900 (i.e., the price of 1 GBP is 1.3900 USD). The exchange rate annualized volatility is 20%. The GBP and USD risk-free rates are 2.5% per annum and 2% per annum, respectively. i. What is the price of a three-month European call option, which enables the buyer to buy GBP at the strike price equal to 1.4000 (i.e., the price of 1 GBP is 1.4000 USD)? ii. What is the price of a three-month European put option, which enables the buyer to buy GBP at the strike price equal to 1.4000 (i.e., 1 GBP can be exchanged to 1.4000 USD)? Use the put-call parity for calculation. (10 marks) c) Verify the put-call parity relationship under no-arbitrage assumption for European call and put options on stock with continuous dividend yield. (10 marks) [Total marks: 35]