3. (a) The price of a European put on XYZ stock that matures in six months...

 

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3. (a) The price of a European put on XYZ stock that matures in six months and has a strike price of £60 is £10. XYZ is currently priced at £65 per share, and is sure to pay a £10 dividend in three months. The continuously compounded risk-free rate is 8% per year for all maturities. What is the price of a European call on XYZ stock with the same maturity (six months) and strike (£60)? Show in detail how you would create an arbitrage if the call price were in fact £1 less than the theoretical price. (b) What can you conclude about the call price in part (a) if the stock cannot be sold short either in the spot nor in the forward markets? 3. (a) The price of a European put on XYZ stock that matures in six months and has a strike price of £60 is £10. XYZ is currently priced at £65 per share, and is sure to pay a £10 dividend in three months. The continuously compounded risk-free rate is 8% per year for all maturities. What is the price of a European call on XYZ stock with the same maturity (six months) and strike (£60)? Show in detail how you would create an arbitrage if the call price were in fact £1 less than the theoretical price. (b) What can you conclude about the call price in part (a) if the stock cannot be sold short either in the spot nor in the forward markets?

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a Pricing the European Call Option 1 PutCall Parity Since we are given the price of a put option and ... View the full answer