Consider a firm which current stock price has experienced a sharp decline from above $40 to...

  

 

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Consider a firm which current stock price has experienced a sharp decline from above $40 to $20 now (at t=0). Suppose an investor believes that the stock price will rebound to $30 at t=1. An investment advisor suggests the investor to buy the following portfolio of options. (a) (b) Sell 1 call option with exercise price E=$20 Buy 2 call options with exercise price E=$30 Sell 1 call option with exercise price E=$36 Draw the payoff of this strategy at t=1. [6p] Should the investor follow the recommendation? Please explain. [2p] Suppose at t=0 the price (premium) of the call with E-$30 is $2.40 and the price of the call with E-$36 is $1.30. Suppose there is no arbitrage. (c) Can you determine the minimum price of the call with E-$20? If so, what is it? If not, what additional information do you need? [4p] Consider a firm which current stock price has experienced a sharp decline from above $40 to $20 now (at t=0). Suppose an investor believes that the stock price will rebound to $30 at t=1. An investment advisor suggests the investor to buy the following portfolio of options. (a) (b) Sell 1 call option with exercise price E=$20 Buy 2 call options with exercise price E=$30 Sell 1 call option with exercise price E=$36 Draw the payoff of this strategy at t=1. [6p] Should the investor follow the recommendation? Please explain. [2p] Suppose at t=0 the price (premium) of the call with E-$30 is $2.40 and the price of the call with E-$36 is $1.30. Suppose there is no arbitrage. (c) Can you determine the minimum price of the call with E-$20? If so, what is it? If not, what additional information do you need? [4p]