Consider a 6-month forward contract, on a stock. The current price of a stock is $200, and the risk-free interest rate is 1% per annum. A dividend will be paid every month, with the amount of the first dividend is $12, but each subsequent dividend will be 0.5% higher than the one previously paid.

(a) Determine the arbitrage strategy given the current prepaid forward in the market is priced at $120.

(b) A 6-month European call option with the stock as the underlying asset and at a strike price of $120 is priced at $12.8.

(i) Calculate the price of a put option with the same strike price and expiration date.

(ii) Calculate the maximum profit of synthetic short forward from (c)(i).

(iii) If the price of the put, in part (c)(i), is fixed at $5, determine the opportunities available for an arbitrageur. Explain the strategy and create the strategy table.

Answer rating: 100% (QA)

SOLUTION a To determine the arbitrage strategy we need to compare the cost of the prepaid forward contract with the cost of replicating it using other financial instruments Heres how we can calculate ... View the full answer