Question 3 Consider a European call option and a European put option that have the same under- lying stock, the same strike price K, and the same expiration date T. Let C denote the Call premium, P denote the Put premium, and S denote the current stock price. Suppose the risk-free borrowing rate r is greater than the risk-free lending rate rɩ, i.e., rɩ > ri. Suppose C < P+S - Ke¯T. Are there arbitrage opportunities? If so, describe your trading strategy; otherwise, list a condition involving r₁, under which an arbitrage strategy exists and describe the strategy.
Question 3 Consider a European call option and a European put option that have the same under- lying stock, the same strike price K, and the same expiration date T. Let C denote the Call premium, P denote the Put premium, and S denote the current stock price. Suppose the risk-free borrowing rate r is greater than the risk-free lending rate rɩ, i.e., rɩ > ri. Suppose C < P+S - Ke¯T. Are there arbitrage opportunities? If so, describe your trading strategy; otherwise, list a condition involving r₁, under which an arbitrage strategy exists and describe the strategy.
Chapter5: Currency Derivatives
Section: Chapter Questions
Problem 28QA
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Transcribed Image Text:Question 3
Consider a European call option and a European put option that have the same under-
lying stock, the same strike price K, and the same expiration date T. Let C denote the Call
premium, P denote the Put premium, and S denote the current stock price. Suppose the
risk-free borrowing rate r is greater than the risk-free lending rate rɩ, i.e., rɩ > ri.
Suppose C < P+S - Ke¯T. Are there arbitrage opportunities? If so, describe your
trading strategy; otherwise, list a condition involving r₁, under which an arbitrage strategy
exists and describe the strategy.
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