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

 

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Consider an n = 1 step binomial tree with T=.5. Suppose r, the annualized risk-free rate is 12 %, and delta, the annualized dividend rate is 11%. Also suppose the annualized standard deviation of the continuously compounded stock return, sigma, is 10 %. Suppose further that the initial stock price, S = $95; and that the strike price K is $ 101. Suppose you observe a put price of $ 4.951, which is lower than the price for the European put option that you computed using the 1-step binomial tree method. By using the arbitrage method outlined in the book, that is, selling a synthetic put option and buying the actual put option: a) Determine the European put 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 ? ? ? ? Consider an n = 1 step binomial tree with T=.5. Suppose r, the annualized risk-free rate is 12 %, and delta, the annualized dividend rate is 11%. Also suppose the annualized standard deviation of the continuously compounded stock return, sigma, is 10 %. Suppose further that the initial stock price, S = $95; and that the strike price K is $ 101. Suppose you observe a put price of $ 4.951, which is lower than the price for the European put option that you computed using the 1-step binomial tree method. By using the arbitrage method outlined in the book, that is, selling a synthetic put option and buying the actual put option: a) Determine the European put 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 ? ? ? ?

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To exploit an arbitrage opportunity we can use a combination of buying and selling options and adjusting the position to guarantee riskfree profit In ... View the full answer