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Unformatted text preview: 1 of 3 NBA673 Introduction to Derivatives I Tibor Jnosi Spring 2006 (1 st half) Homework 4: Options Due in class on Thursday, March 9 . Your answers should be as clear, precise, and brief as possible. Show your work, e.g. write down the formulas you are using in their general form and explain very concisely why you are using them. If submissions are illegible, they will not be graded. When presenting an abstract argument, make sure that your arguments are logically consistent, complete, and that they cover all cases that might occur. Justify all your claims based on facts given to you in the problem or proven in class. Remember to read the homework FAQ from time to time (do it one final time just before you submit your homework). The FAQ is posted when questions of general interest are first posed; it contains clarifications, corrections (if needed), and other information that you will likely find useful. Problem 1: A stock is trading at $50. Suppose you purchase a European call option with an exercise price of $45 and write a call option with an exercise price of $55. Both options mature at the same time. (a) Draw the payoff diagram of this portfolio when the options mature. Justify your answer by explicitly examining the value of the portfolio for one underlying stock value from all intervals of interest. (b) Develop a portfolio that has identical payoff to the portfolio above, but use only puts and perhaps the underlying stock and/or cash. (c) The portfolio given above is known as a bullish vertical spread. Try to explain this name. Problem 2: A stock is trading at $30. Suppose you write a European call with an exercise price of $25 and buy a call with exercise price $35. Both options mature on the same date....
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- Spring '06