1. You are creating a Straddle long position by buying a stock call option and a stock put option simultaneously. The two options have the same strike price at $50 per share. The call premium is $4 per share and the put premium is $10 per share. Please solve for (a) the profit/loss of the straddle position at per share level, if the stock price becomes $80; (b) the profit/loss from the call option only at per share level, if the stock price becomes $40; (c) the Break-Even points of the straddle position.

2. Covered Interest Arbitrage on a 3-month horizon (10 points)

US interest rate = 12%

Euro zone interest rate = 2%

The current spot rate is $1.25/

The Futures rate is $1.30/

a. Whats the best investment strategy for the arbitrageurs? Please list all steps

b. What is the profit of the covered interest arbitrage, given the size of trade is $5,000,000?

c. Once the arbitrageurs around the globe execute their strategy, the following would happen

US interest Rate _______________ (increase or Decrease)

The Futures rate _______________ (increase or Decrease)

3. Interest rate swap

The following questions are based on the case provided below

Able Inc. and Baker Inc. face the following borrowing costs in the fixed and floating rate markets:

FixedRate Market Floating Rate Market

Baker 11. 90% L + 0.20%

Able 10.75% L 0.15%

Each firm desires the rate other than that for which it has comparative advantage.

A dealer stands ready to enter into a swap as either a fixedrate payer or floating-rate receiver (or vice versa). The dealer will pay a fixed 11.22% against LIBOR or receive 11.30% against LIBOR. Assume that each firm borrows in the market in which it has comparative advantage and enters into a swap agreement. Analyze the potential gains from swapping for all parties under the following headlines:

a. What does the swap dealer earn?

b. Obtain the effective loan rate for Able. List all loans Able deals with.

c. By how much is Baker better-off from the swap agreement?

d. What is the overall benefit of the three parties: Able, Baker and the Dealer?