Suppose that you observe the following data:

XYZ Widgets stock is trading at $100 per share.

European Call Option with T = 1 and K = $110 is trading for $20.

The risk-free rate is 5%.

1. If the Law of One Price holds, what should the price of a European Put Option with

T = 1 and K = $110 be?

2. Draw the T = 1 payoffff to a portfolio where you buy the European Call Option, sell

the European Put Option, and invest $104.76 at the risk-free rate (for a year). What

does this payoffff diagram look like? What is the price of this portfolio if the Law of

One price holds?

3. Suppose instead that the price of the European Put Option is $23. Knowing this, and

your answers to (a) and (b), construct a trading strategy that takes advantage of this

violation of the Law of One Price.