Suppose that you observe the following: The price of a call option on the Euro (€) is 0.055 $/€. The price of a put option on the € is 0.045 $/€. Both options have 92 days left to expiration and a strike price of 0.85 $/€. The current spot rate is 0.89 $/€. The $-risk-free rate is 3.5% and the €-risk-free rate is 3.75%. 

a) Is there an arbitrage opportunity? Why? 

b) Calculate the arbitrage profits and show the arbitrage transactions and corresponding cash flows at t=0 (now) and at t=T=92 days later.

Answer rating: 100% (QA)

Part a Recall the call put parity condition C0 P0 S0e r x t Ke r x t Or C0 P0 S0e r x t Ke r x t 0 w... View the full answer