Consider two strategies: Strategy 1: Purchase one unit of Asset M currently selling for ($ 103). A
Question:
Consider two strategies:
Strategy 1: Purchase one unit of Asset M currently selling for \(\$ 103\). A distribution of \(\$ 10\) is expected one year from now.
Strategy 2:
(a) Purchase a call option on Asset M with an expiration date one year from now an \(f\) a strike price of \(\$ 100\); and
(b) place sufficient funds in a \(10 \%\) interest-bearing bank account to exercise the option at expiration ( \(\$ 100\) ) and to pay the cash distribution that would be paid by Asset M (\$10).
a. What is the investment required under Strategy 2?
b. Give the payoffs of Strategy 1 and Strategy 2, assuming that the price of Asset \(M\) one year from now is
(i) \(\$ 120\)
(ii) \(\$ 103\)
(iii) \(\$ 100\)
(iv) \(\$ 80\)
c. For the four prices of Asset \(M\) one year from now, demonstrate that the following relationship holds: Call option price \(\geq \operatorname{Max}[0\), (Price of underlying asset - Present value of strike price - Present value of cash distribution)].
Step by Step Answer:
Foundations Of Financial Markets And Institutions
ISBN: 9780136135319
4th Edition
Authors: Frank J Fabozzi, Franco G Modigliani, Frank J Jones