Suppose that a certain stock trades at $50 (there will be no dividends.) A European put expiring in 1 month struck at K = $40 trades at $5. A European call with the same strike and expiration also 3 trades at $10. If the risk free rate is 0%, there will be an arbitrage opportunity by (i) selling the put and short sell the stock and (ii) buying the bond and call. Hint: remember we make money in finance by buying low and selling high. Solution:
Suppose that a certain stock trades at $50 (there will be no dividends.) A European put expiring in 1 month struck at K = $40 trades at $5. A European call with the same strike and expiration also 3 trades at $10. If the risk free rate is 0%, there will be an arbitrage opportunity by (i) selling the put and short sell the stock and (ii) buying the bond and call. Hint: remember we make money in finance by buying low and selling high. Solution:
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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Transcribed Image Text:Suppose that a certain stock trades at $50 (there will be no dividends.) A European put expiring in
1 month struck at K = $40 trades at $5. A European call with the same strike and expiration also
3
trades at $10. If the risk free rate is 0%, there will be an arbitrage opportunity by (i) selling the put
and short sell the stock and (ii) buying the bond and call. Hint: remember we make money in finance
by buying low and selling high.
Solution:
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