Question: (a) The table below shows the data relating to two call options. Beta Price Expiry Exercise Stock (Months) Price Price AYE Call 1.2 $6 9

(a) The table below shows the data relating to two call options. Beta Price Expiry Exercise Stock (Months) Price Price AYE Call 1.2 $6 9 $30 $35 PIE Call 1.4 $6 9 $30 $35 The AYE call expiring in 6 months is correctly priced. Appraise whether the PIE call expiring in 6 months is consistently priced in relation to the AYE call expiring in 6 months. If there is insufficient information available to determine the consistency in the pricing of the calls, give your reasons. (10 marks

(b) (i) You are a gold trader looking for arbitrage opportunities. The spot price of gold is currently $1,800 per ounce. The futures contract price for delivery in 6 months is $1,850. Storage cost is fixed at $10 per ounce for 6 months.

Appraise and value (compute) the borrowing cost above which arbitraging the two prices is not profitable.

(ii) If you were to formulate a strategy to hedge the gold inventory, would you agree with the jeweller who made the following remark? “I’ve hedged my inventory of gold with gold futures contracts, so my inventory is perfectly hedged against changes in gold prices.”

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