Question 3. (This question has three parts: I, II and III)

Part I.

A trader sells a strangle by selling a call option with a strike price of $52 for $1 and selling a put option with a strike price of $43 for $8. For what range of prices of the underlying asset does the trader make a profit?

Part II.

Assume that you observe the following. The spot exchange rate between the Swiss Franc and U.S. dollar was 1.0404 ($ per franc). Interest rates in the U.S. and Switzerland were 2.5% and 1.0% per annum, respectively, with continuous compounding. The three-month forward exchange rate was 1.0503 ($ per franc). Present a possible arbitrage strategy and show your profit.

Part III.

A hedge fund is currently engaged in a plain vanilla interest rate swap with a company. Under the terms of the swap, the hedge fund receives a six-month LIBOR and pays 6% per annum on a principle of $100 million for five years. Payments are made every 6 months. Assume that the interest rates start to soar after two years and the company defaults on the sixth payment date when the LIBOR rate is 8 per cent for all maturities (with semi-annual compounding). The 6-months LIBOR rate 6-months ago is 7.5%. What is the loss to the hedge fund?