Question 5 Not yet answered Marked out of 23.0 Flag question. You are interviewing a candidate for a position. The questions you ask are as follows. 1. What are the different types of market participants in derivatives markets? Will they pay different prices? If so, what may happen? (3 marks) 2. Do the payoff and profit diagrams for a long position in a forward contract differ? Describe in words, or by a formula, how the payoff and profit diagrams for a long position in a European call option differ, if at all. (NB: No marks will be awarded for providing a diagram, but you may do so if you choose.) (2 marks) 3. Why do the premiums of call options increase as the strike prices decrease while the premiums of put options decrease as the strike prices decrease? (4 marks) 4. Using an example, name a reason why an arbitrage opportunity could persist in the market? (3 marks) 5. Suppose European call and put options on Tron Ltd shares are selling for $2.82 and $3.02, respectively. Both options are struck at $7.63 (per share) and mature in nineteen months. The current stock price of Tron is $6.89 per share and the risk-free rate is 1.4% p.a. As the same time, suppose you observe that forward contracts on Tron shares with seventeen months to expiration are trading at $6.82 (per share). a) Using option contracts only, indicate what strategy you would implement in taking advantage of any arbitrage opportunity and the profit per share you would earn from your strategy (Note: You are required to use a table to outline the initial and terminal values of your strategy). (6 marks) b) Using forward contracts only, indicate what strategy you would implement in taking advantage of any arbitrage opportunity and the profit per share you would earn from your strategy (Note: You are required to use a table to outline the initial and terminal values of your strategy). (5 marks) Question 5 Not yet answered Marked out of 23.0 Flag question. You are interviewing a candidate for a position. The questions you ask are as follows. 1. What are the different types of market participants in derivatives markets? Will they pay different prices? If so, what may happen? (3 marks) 2. Do the payoff and profit diagrams for a long position in a forward contract differ? Describe in words, or by a formula, how the payoff and profit diagrams for a long position in a European call option differ, if at all. (NB: No marks will be awarded for providing a diagram, but you may do so if you choose.) (2 marks) 3. Why do the premiums of call options increase as the strike prices decrease while the premiums of put options decrease as the strike prices decrease? (4 marks) 4. Using an example, name a reason why an arbitrage opportunity could persist in the market? (3 marks) 5. Suppose European call and put options on Tron Ltd shares are selling for $2.82 and $3.02, respectively. Both options are struck at $7.63 (per share) and mature in nineteen months. The current stock price of Tron is $6.89 per share and the risk-free rate is 1.4% p.a. As the same time, suppose you observe that forward contracts on Tron shares with seventeen months to expiration are trading at $6.82 (per share). a) Using option contracts only, indicate what strategy you would implement in taking advantage of any arbitrage opportunity and the profit per share you would earn from your strategy (Note: You are required to use a table to outline the initial and terminal values of your strategy). (6 marks) b) Using forward contracts only, indicate what strategy you would implement in taking advantage of any arbitrage opportunity and the profit per share you would earn from your strategy (Note: You are required to use a table to outline the initial and terminal values of your strategy)
