Suppose that a Stock has a current price of $40 and that in 6-months it may go up by 20% or down by 15%. Assuming the annual risk-free rate is 3%, compounded semi-annually, answer the following: a) Calculate the value of a $35 Call with two 6-month periods (i.e. 12-months) to expiry using the Risk Neutral Approach. b) Calculate the value of a $35 Put using Put-Call Parity. c) Without performing any calculations, explain in 1-2 sentences what you would expect to happen to the value of the Call and Put if the Exercise Price decreased. d) Do this question in the blank space below - i.e. DO NOT answer this sub-part (d) in Excel. Only your solution written below will be marked: Suppose the market price of a 12-month Call with an exercise price of $35 is $6.00. The Put price is as you calculated in (b) above. Using a payoff table, illustrate an arbitrage opportunity as a result of the mispricing of the Call. Show your workings to 3 decimal places. (If you need more space, please use the back of this page).

Pfin (with Mindtap, 1 Term Printed Access Card) (mindtap Course List)
7th Edition
ISBN:9780357033609
Author:Randall Billingsley, Lawrence J. Gitman, Michael D. Joehnk
Publisher:Randall Billingsley, Lawrence J. Gitman, Michael D. Joehnk
Chapter12: Investing In Stocks And Bonds
Section: Chapter Questions
Problem 1FPE: What makes for a good investment? Use the approximate yield formula or a financial calculator to...
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Suppose that a Stock has a current price of $40 and that in 6-months it may go up by 20%
or down by 15%. Assuming the annual risk-free rate is 3%, compounded semi-annually,
answer the following:
a) Calculate the value of a $35 Call with two 6-month periods (i.e. 12-months) to expiry
using the Risk Neutral Approach.
b) Calculate the value of a $35 Put using Put-Call Parity.
c) Without performing any calculations, explain in 1-2 sentences what you would expect
to happen to the value of the Call and Put if the Exercise Price decreased.
d) Do this question in the blank space below - i.e. DO NOT answer this sub-part (d) in
Excel. Only your solution written below will be marked:
Suppose the market price of a 12-month Call with an exercise price of $35 is $6.00. The
Put price is as you calculated in (b) above. Using a payoff table, illustrate an arbitrage
opportunity as a result of the mispricing of the Call. Show your workings to 3 decimal
places. (If you need more space, please use the back of this page).
Transcribed Image Text:Suppose that a Stock has a current price of $40 and that in 6-months it may go up by 20% or down by 15%. Assuming the annual risk-free rate is 3%, compounded semi-annually, answer the following: a) Calculate the value of a $35 Call with two 6-month periods (i.e. 12-months) to expiry using the Risk Neutral Approach. b) Calculate the value of a $35 Put using Put-Call Parity. c) Without performing any calculations, explain in 1-2 sentences what you would expect to happen to the value of the Call and Put if the Exercise Price decreased. d) Do this question in the blank space below - i.e. DO NOT answer this sub-part (d) in Excel. Only your solution written below will be marked: Suppose the market price of a 12-month Call with an exercise price of $35 is $6.00. The Put price is as you calculated in (b) above. Using a payoff table, illustrate an arbitrage opportunity as a result of the mispricing of the Call. Show your workings to 3 decimal places. (If you need more space, please use the back of this page).
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