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Assume: • current stock price = $20 • stock price changes by +/-10% each 3 months with equal probability European call option, strike $21, maturity 3 mths ● • constant riskfree rate of 12% p.a. • 1 time period to maturity • current price of call option is $0.50 Show how the concept of a riskless hedge may be used to exploit the arbi opportunity.

Assume: • current stock price = $20 • stock price changes by +/-10% each 3 months with equal probability European call option, strike $21, maturity 3 mths ● • constant riskfree rate of 12% p.a. • 1 time period to maturity • current price of call option is $0.50 Show how the concept of a riskless hedge may be used to exploit the arbi opportunity.

Essentials Of Investments
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
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QUESTION 3 Assume: • current stock price = $20 • stock price changes by +/-10% each 3 months with equal probability European call option, strike $21, maturity 3 mths • constant riskfree rate of 12% p.a. ● 1 time period to maturity • current price of call option is $0.50 ● Show how the concept of a riskless hedge may be used to exploit the arbitrage opportunity.
Transcribed Image Text:QUESTION 3 Assume: • current stock price = $20 • stock price changes by +/-10% each 3 months with equal probability European call option, strike $21, maturity 3 mths • constant riskfree rate of 12% p.a. ● 1 time period to maturity • current price of call option is $0.50 ● Show how the concept of a riskless hedge may be used to exploit the arbitrage opportunity.
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