Calls on a stock are selling for $25 (X= $ 110, T=1 year).  Risk free rate is 10% per year.  You are an investment banker and you want to sell a 'guaranteed investment contract (GIC)'.  This is the newest fancy acronym of your creation. Such a package will allow the buyer to enjoy all the upside benefits of a stock while the downside is limited to $ 110.  For example if I buy 1 unit of GIC, and the stock price is say $ 200 (one year from today), I will receive $ 200 for one unit of GIC.  However, if the stock price is below $ 110 (one year from today), you provide a guarantee that I will receive $ 110 for one unit of GIC.  Your guarantee is iron-clad with zero risk of default. Ignore transaction costs, fees, commissions etc.

Find the fair market value of one unit of GIC.

Answer rating: 100% (QA)

To find the fair market value of one unit of GIC we can use the principle of noarbitrage The idea is ... View the full answer