Question
The price of a European put that expires in seven months and has a strike price of $74 is $1.26. The underlying stock price is
The price of a European put that expires in seven months and has a strike price of $74 is $1.26. The underlying stock price is $77, and a dividend of $2 is expected in three months. The term structure is flat, with all risk-free interest rates being 6% (cont. comp.).
a. What is the price of a European call option on the same stock that expires in seven months and has a strike price of $74? [1 mark]
b. Based on the result you obtained in a.: Compare the put and the call price. Which one is higher and why? [1 mark]
c. Explain in detail the arbitrage opportunities if the European call price is $3.5. How much will the arbitrage profit be? [4 marks]
d. Explain in detail the arbitrage opportunities if the European call price is $6.0. How much will the arbitrage profit be? [4 marks]
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