Question: Consider an n = 1 step binomial tree with T = .5. Suppose r, the annualized risk-free rate is 5 %, and delta, the

Consider an n = 1 step binomial tree with T = .5. Suppose r, the annualized risk-free rate is 5 %, and delta,

Consider an n = 1 step binomial tree with T = .5. Suppose r, the annualized risk-free rate is 5 %, and delta, the annualized dividend rate is 4 %. Also suppose the annualized standard deviation of the continuously compounded stock return, sigma, is 40 %. Suppose further that the initial stock price, S = $ 85; and that the strike price K is $ 109. Suppose you observe a call price of $ 3.124, which is higher than the price for the European call option that you computed using the 1-step binomial tree method. By using the arbitrage method outlined in the book, that is, buying a synthetic call option and selling the actual call option: a) Determine the European call premium b) Determine the number of shares of stock that you'll buy c) Determine the amount of money that you'll borrow d) Determine the risk free profit from this arbitrage opportunity ? ? ? ?

Step by Step Solution

★★★★★

3.48 Rating (148 Votes )

There are 3 Steps involved in it

1 Expert Approved Answer

Step: 1 Unlock

Step 1 Introduction of the option An American call option is a financial contract t... View full answer

Question Has Been Solved by an Expert!

Get step-by-step solutions from verified subject matter experts

Step: 2 Unlock

Step: 3 Unlock

Students Have Also Explored These Related Accounting Questions!

K Find the product. [2-1][3] -8

2 3. Add a red person until all of them are pulling on the rope. observe what will happen to the change in speed. Measure the time in seconds and speed in the number of lines indicated in the...

KYC's stock price can go up by 15 percent every year, or down by 10 percent. Both outcomes are equally likely. The risk free rate is 5 percent, and the current stock price of KYC is 100. (a) Price a...

Migration is a popular strategy among many species. Monarch butterflies migrate between the Sierra Madre mountains in Mexico and many locations across the USA and Canada. Answer the following...

A child slides down a slide inclined at 30 in time t 1 . The coefficient of kinetic friction between her and the slide i s k . She finds that if she sits on a small cart with frictionless wheels,...

Which costs are assigned using the weighted-average method?? LO7

Consider the continuous sample space = [1, 1000]. For each event A in (A ), we define the probability P(A) to be k1000, where k is the number of integers included in the set A. Then: (i) Show that...

You will need the working papers that accompany this textbook in order to work this mini practice set. Bluma Co. uses a perpetual inventory system and both an accounts receivable and an accounts...

Answer and explain Weller Company's budgeted unit sales for the upcoming fiscal year are provided below: The company's variable selling and odministrative expense per unit is $3.00. Fixed selling and...

You have been employed as a consultant to Golf R Us, Inc. The company has been having problems with account receivables and they want to use various dunning methods to better their receivables. But...

Required information Problem 4-26A Comprehensive cycle problem: Perpetual system LO 4-2, 4-3, 4-4, 4-5, 4-6, 4-7 [The following information applies to the questions displayed below.) At the beginning...

Cain Company reports net cash provided by operating activities of $33,000. It also reports the following information under "Adjustments to reconcile net income to net cash provided by operating...

The following data represent the monthly phone use, in minutes, of a customer enrolled in a fraud prevention program for the past 20 months. The phone company decides to use the upper fence as the...

To keep its customers happy, protect its financial performance, and protect its competitive advantage, a company must continually evaluate all the business processes in its value chain. Improving the...

15. MC.02.93 The accounts in the ledger of Monroe Entertainment Co. are listed below. All accounts have normal balances. Accounts payable $1,500 Fees earned $8,600 Accounts receivable 1,800 Insurance...

7. During the Spring Festival at the university, the bumper car stand has a problem with cars breaking down and needing repair. Mechanics can be hired to do this at a salary of $20 per hour, but they...

Problem 2 ( 4 0 pts ) A fuel of molar composition C H 4 ( 6 0 % ) , C 2 H 6 ( 2 0 % ) , C O ( 5 % ) , O 2 ( 5 % ) and N 2 ( 1 0 % ) is supplied with air [ molar composition O 2 ( 2 1 % ) and N 2 ( 7...

The figure shows six containers, each of which is filled from the top. Assume that water is poured into the containers at a constant rate and each container is filled in 10 seconds. Assume also that...

Prove that if a | b and b | c, then a | c.

A carnival game consists of three dice in a cage. A player can bet a dollar on any of the numbers 1 through 6. The cage is shaken, and the payoff is as follows. If the players number doesnt appear on...

Give an O(n lg n)-time algorithm to determine whether an n-vertex polygon is simple.

Describe the conditions for using the annual exclusion to offset an otherwise taxable transfer.

Explain why the gross estate includes the value of certain property transferred by the decedent at death, such as property held in joint tenancy with the right of survivorship, even though this...

Describe a reason why transfers of terminable interests should not qualify for the marital deduction.