Question: Given the following data, construct an arbitrage strategy: S = 95, K = 100, T = 1/2 year, D = 3 in three months, r

Given the following data, construct an arbitrage strategy: S = 95, K = 100, T = 1/2 year, D = 3 in three months, r = 0.05, and P_E = 4.

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We check that PE PVK PVD S PVK 97531 and PV D 29627 hence PV K PV D S 97531 2962795 54937 Note that the price of the put is less than 54937 thereby offering an arbitrage opportunity We construct this as follows Buy the put since it is undervalued outflow 4 Buy the stock outflow 95 Borrow PVK inflow 97531 Borrow PV D inflow 29627 Hence the net cashflow at inception is 495 97531 29627 ... View full answer

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