Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
12th Edition
ISBN: 9781259144387
Author: Richard A Brealey, Stewart C Myers, Franklin Allen
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 20, Problem 21PS
Put–call parity
- a. If you can’t sell a share short, you can achieve exactly the same final payoff by a combination of options and borrowing or lending. What is this combination?
- b. Now work out the mixture of stock and options that gives the same final payoff as investment in a risk-free loan.
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Use the put-call parity relationship to demonstrate that an at-the-money call option on a nondividend-paying stock must cost more than an at-the-money put option. Show that the prices of the put and call will be equal if So = (1 + r)^T
PART B
Arbitrage is the idea that one can (select the best answer):
Group of answer choices
Buy and Sell different assets or packages of assets at different prices such you can earn a riskless profit without investing any capital.
Earn rates of return greater than the average for the market by successfully “picking” stocks.
Earn abnormal returns above what CAPM would predict for a particular security.
Chapter 20 Solutions
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 20 - Vocabulary Complete the following passage: A _____...Ch. 20 - Option payoffs Note Figure 20.13 below. Match each...Ch. 20 - Option combinations Suppose that you hold a share...Ch. 20 - Put-call parity What is put-call parity and why...Ch. 20 - Prob. 5PSCh. 20 - Option combinations Dr. Livingstone 1. Presume...Ch. 20 - Option combinations Suppose you buy a one-year...Ch. 20 - Prob. 8PSCh. 20 - Prob. 9PSCh. 20 - Option values How does the price of a call option...
Ch. 20 - Option values Respond to the following statements....Ch. 20 - Option combinations Discuss briefly the risks and...Ch. 20 - Option payoffs The buyer of the call and the...Ch. 20 - Option bounds Pintails stock price is currently...Ch. 20 - Putcall parity It is possible to buy three-month...Ch. 20 - Prob. 16PSCh. 20 - Option values FX Bank has succeeded in hiring ace...Ch. 20 - Option combinations Suppose that Mr. Colleoni...Ch. 20 - Put-call parity A European call and put option...Ch. 20 - Putcall parity a. If you cant sell a share short,...Ch. 20 - Putcall parity The common stock of Triangular File...Ch. 20 - Prob. 23PSCh. 20 - Option combinations Option traders often refer to...Ch. 20 - Option values Is it more valuable to own an option...Ch. 20 - Option values Table 20.4 lists some prices of...Ch. 20 - Option values Youve just completed a month-long...Ch. 20 - Prob. 29PSCh. 20 - Prob. 30PS
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Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Which of the following statements is true? A. Because of flotation costs, dollars raised by retaining earnings must work harder than dollars raised by selling new shares. B. All other things being equal, a call option price will increase, and a put option price will decrease if an exercise price increases. C. Security market line (SML) plots return against total risk which is measured by the standard deviation of returns. D. Because potential long-term returns, income from rent-payments, diversification, and inflation hedge, real-estate would be a good investment.arrow_forwardTrue or False. and briefly explain. a. Under the Capital Asset Pricing Model (CAPM), if a stock has a zero beta, then it must be identical to the riskfree asset. b. For Value at Risk (VaR) to be useful, the returns have to be normally distributed. c.If the borrowing rate is higher than the lending rate, a particular risk-averse investor can achieve a maximized utility score of UC* by choosing optimally. Now if the borrowing rate is equal to the lending rate, this investor must be able to achieve a utility score higher than UC*arrow_forwardSuppose that C is the price of a European call option to purchase a security whose present price is S.Show that if C > S then there is an opportunity for arbitrage (i.e. riskless profit). You may assume theinterest rate is r = 0 so that present value calculations are unnecessary.arrow_forward
- Discuss how the concept of pure security, short selling and no arbitrage profit help establish and understand the equilibrium from the capital markets. Discuss different economic determinants security prices. Kindly answer the question as soon as possible.arrow_forwardConsider a capital market with two securities. The payoffs of these securities in the two equally likely states of the world are given in the table below. Рayolf Price Security State 1 State 2 PA=2 A 4 2 PB-3 B a. Discuss the concepts of complete capital markets, pure (Arrow-Debreu) securities, and pure factor portfolios. Establish whether the capital market in this case is complete and determine the prices of the pure socurities by arbitrage.arrow_forward“Even in an efficient market, it is still valid to seek out a ‘favourable’ rate of returnfrom an equity investment. In an efficient market, one security is as good as any other.”Do you agree with this statement? Discuss your point of view.arrow_forward
- a. Explain the covered call options strategy b. Graphically show a covered call options strategy, including payoff. Explain why an investor mayuse this option strategy.c. Using put-call parity, explain the shape of the payoff line (in part (a) of this question). Whatoption position does it look like and why?arrow_forwardPut–Call Parity - A put and a call have the same maturity and strike price. If they have the same price, which one is in the money? Prove your answer and provide an intuitive explanation.arrow_forwardWhat is Put-Call Parity (select the best answer)? Group of answer choices Put-Call Parity suggests that puts and calls have equal, but opposite, values. Uses arbitrage arguments showing that a portfolio of the underlying stock plus a put has the exact same payoffs as a portfolio of a risk-free bond plus a call. Thus, those two portfolios must have equal value. Uses arbitrage arguments to show that the value of a Put is equal to the value of a Call plus the Stock Price. Uses arbitrage arguments to show that the value of a Call is equal to the value of the underlying stock plus the value of a Put.arrow_forward
- Suppose that C is the price of a European call option to purchase a security whose present price is S. Show that if C>S then there is an opportunity for arbitrage (i.e. risk-less profit). You may assume the interest rate is r=0 so that the present value calculations are unnecessary.arrow_forwardIdentify the correct statement related to the choice of exercise price for buying a call. Select one: O a. the higher the exercise price the higher the call premium O b. the lower the exercise price the more likely the call option will expire out-of-the-money O c. A higher strike price results in smaller gains on the upside but smaller losses on the downside O d. the higher the exercise price the more dividends contribute to the overall profitarrow_forwardMy question is for a synthetic call option why do we need to borrow the present value of the strike price and what does it mean in a simple language explanation. Similarly why do we need to lend the present value of the stock at risk-free rate and what does it mean in simple language explanation? Please also clarify the significance of risk free rate? Why is it used in put call parity. Synthetic Call Option: If an investor believes that a call option is over-priced, then he/she can sell the call on the market and replicate a synthetic call. Borrow the present value of the strike price at the risk free rate and purchase the underlying stock and a put. Synthetic Put Option: Similar to the synthetic call option. A synthetic put can be created by re-arranging the put-call parity relationship, if the trader believes the put is overvalued. Synthetic Stock: A synthetic stock can also be created by rearranging the put-call parity identity. In this case, the investor will buy the…arrow_forward
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