Answer the following as True or False

QUESTION 1 When the forward price is above the spot price, market participants expect the price of the asset to rise. QUESTION 2 Consider a security that costs P0 at t=0 and pays ST at time t=T, where St is the time t price of a commodity that has a convenience yield and storage cost. Unless P0 is the same as the forward price for delivery at time T, F0_T, there will be an arbitrage opportunity. QUESTION 3 A risk reversal is a strategy where you are short an out of the money put and long an out of the money call. Because risk reversals are short a bet on down (the put) and long a bet on up (the call), they must have positive vega. QUESTION 4 Suppose that the assumptions of the BSM model hold. Supposing that the expected return of a stock is higher than the risk- free rate. the expected return of call option with K = 100 will be lower than the expected return on a call option with K = 110. QUESTION 5 Since market participants demand compensation for bearing risk, we can view risk-neutral pricing as only a rough approximation of reality. QUESTION 6 Consider a binomial model where the risk-free rate is 10%. If the price of a digital up option is $0.70, the price of a digital down option must be $0.40. QUESTION 7 Consider a stock following geometric Brownian motion with 80 = 100, p = 16%, o = 20%. After one year the stock price will (on average) be $100e0-16 = $117.35. If one wants to buy an insurance contract that pays $1 if the stock performance is below average (i.e. if 81