The current price of Google stock is 100, and its price could be either 120 or 80
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Question:
- The current price of Google stock is 100, and its price could be either 120 or 80 after 1 year. The annual risk-free rate is 10%. The one-year call option on Google stock has a strike price of $100.
- Using the hedging approach, what is the hedge ratio and what is the call options price?
For the following questions, assume you can only either buy or short sell 1 share of stock. You will build an arbitrage portfolio with initial cash flow = 0. You will be asked about your profit in 1 year.
- Assume the one-year calls market price is $15. Calculate the arbitrage profit you can make in one year.
- Assume the one-year calls market price is $10. Calculate the arbitrage profit you can make in one year.
- Assume the one-year calls market price is $15, the lending interest rate is still 10%, but the borrowing rate is 15%. Is there still an arbitrage opportunity? First answer yes or no. Then show your calculation to justify your answer.
- Assume the one-year calls market price is $15, the lending interest rate is still 10%, what is the highest borrowing rate at which you can still make an arbitrage profit?
- Assume the one-year calls market price is $10, the lending interest rate is still 10%, but the borrowing rate is 15%. Is there still an arbitrage opportunity? First answer yes or no. Then explain.
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