Question 5 (a) The current market price of a three-month European put option on a non-dividend...

Transcribed Image Text:

Question 5 (a) The current market price of a three-month European put option on a non-dividend paying stock with a strike price of 43 is 5.50. The stock price is 45.00, and the risk-free interest rate is 6.5%. i. If a three-month call option with the same strike price is currently selling for 3.50, what opportunities are there for an arbitrageur? How can he exploit this arbitrage? Explain your answer and show all workings. [25%] ii. Would the market prices listed above still provide an arbitrage opportunity if the stock price was 40.77 per share in one month? Explain your answer and show all workings. [15%] (b) What is the probability that a European call option on a stock with an exercise price of 53.00 and a maturity date in twelve months will be exercised? The current stock price is 46.00, the interest rate is 7.65% per annum, and stock return volatility is 31.00% per annum. Explain answer and show all workings. your [30%] (c) A stock is currently selling for 70.00. A put option has a maturity of 2 years, and during this time, the stock price is expected to increase by 35% or to decrease by 25% in each year. The annual risk-free interest rate is 6.0% and the strike price is 65.00. The put option is currently selling for 6.00. Is the option more likely an American or European put option? Use a 2-step binomial option pricing model to determine the answer. [30%] Question 5 (a) The current market price of a three-month European put option on a non-dividend paying stock with a strike price of 43 is 5.50. The stock price is 45.00, and the risk-free interest rate is 6.5%. i. If a three-month call option with the same strike price is currently selling for 3.50, what opportunities are there for an arbitrageur? How can he exploit this arbitrage? Explain your answer and show all workings. [25%] ii. Would the market prices listed above still provide an arbitrage opportunity if the stock price was 40.77 per share in one month? Explain your answer and show all workings. [15%] (b) What is the probability that a European call option on a stock with an exercise price of 53.00 and a maturity date in twelve months will be exercised? The current stock price is 46.00, the interest rate is 7.65% per annum, and stock return volatility is 31.00% per annum. Explain answer and show all workings. your [30%] (c) A stock is currently selling for 70.00. A put option has a maturity of 2 years, and during this time, the stock price is expected to increase by 35% or to decrease by 25% in each year. The annual risk-free interest rate is 6.0% and the strike price is 65.00. The put option is currently selling for 6.00. Is the option more likely an American or European put option? Use a 2-step binomial option pricing model to determine the answer. [30%]

Answer rating: 100% (QA)

The image shows a financerelated question which includes three parts a b and c Each part contains a problem about options pricing and asks to determine opportunities for arbitrage probabilities of exe... View the full answer