. [Put-Call Parity Condition] At date t, there is a European call option on the dollar with a strike price of K = 0.75 and an expiration date of T>t and a European put option on the dollar with the same strike price and expiration date. Both are notional one dollar (N=1). The risk-free interest rate in the UK is r = 1/5 (20%) and the risk-free interest rate in the US is = 1/4 (25%). The current spot exchange rate is
. [Put-Call Parity Condition] At date t, there is a European call option on the dollar with a strike price of K = 0.75 and an expiration date of T>t and a European put option on the dollar with the same strike price and expiration date. Both are notional one dollar (N=1). The risk-free interest rate in the UK is r = 1/5 (20%) and the risk-free interest rate in the US is = 1/4 (25%). The current spot exchange rate is
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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E3
![3. [Put-Call Parity Condition] At date t, there is a European call option on the dollar
with a strike price of K = 0.75 and an expiration date of T >t and a European put
%3D
option on the dollar with the same strike price and expiration date. Both are notional
one dollar (N = 1). The risk-free interest rate in the UK is r 1/5 (20%) and the
risk-free interest rate in the US is r= 1/4 (25%). The current spot exchange rate is
S, = 0.8 (that is, each dollar costs 80 pence).
%3D
(a) You buy the put option at the price of P, = 2.5 pence. Explain the position you
have at the expiration date T.
(b) Five minutes later you find out that the equivalent call is trading at C, = 5 pence.
You know the put-call parity condition for European options is
S;
(1+r) (1+r)"
K
C- P, =
Identify an arbitrage opportunity. What position do you take? Explain all the
cash flows at date t and at the expiration date T.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F39143d27-4ed0-4cb6-a256-365d5c101b35%2F2e27df99-0787-47ab-a0ae-9970a208211d%2F7az49ee_processed.jpeg&w=3840&q=75)
Transcribed Image Text:3. [Put-Call Parity Condition] At date t, there is a European call option on the dollar
with a strike price of K = 0.75 and an expiration date of T >t and a European put
%3D
option on the dollar with the same strike price and expiration date. Both are notional
one dollar (N = 1). The risk-free interest rate in the UK is r 1/5 (20%) and the
risk-free interest rate in the US is r= 1/4 (25%). The current spot exchange rate is
S, = 0.8 (that is, each dollar costs 80 pence).
%3D
(a) You buy the put option at the price of P, = 2.5 pence. Explain the position you
have at the expiration date T.
(b) Five minutes later you find out that the equivalent call is trading at C, = 5 pence.
You know the put-call parity condition for European options is
S;
(1+r) (1+r)"
K
C- P, =
Identify an arbitrage opportunity. What position do you take? Explain all the
cash flows at date t and at the expiration date T.
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