{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

ps8 - ECO 362 PROBLEM SET 81 FINANCIAL INVESTMENTS...

Info icon This preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
ECO 362 December 13, 2007 PROBLEM SET 8 1 FINANCIAL INVESTMENTS Professor: Burt Malkiel Exercise 1 (a) The Put-Call parity states C 0 = S 0 + P 0 μ 1 1 + r f T X where S 0 is the current price of the stock, C 0 and P 0 are the current value of European call and put options written on S and with the same strike (exercise price) X and same time to expiration T , and r f is the risk free rate. Hence, to replicate a one-year pure discount bond with a face value of $100 , we have to: buy a share of stock, buy European put with an exercise price of $100 , and sell a European call with an exercise price of $100 . (b) We know T = 1 , X = 100 S 0 = 100 , P 0 = 10 , and C 0 = 15 . Then, the Put-Call parity formula X 1 + r f = S 0 + P 0 C 0 implies r f = X S 0 + P 0 C 0 1 = 100 100 + 10 15 1 = 5 . 3% . (c) If r = 4% , then one could make risk-free arbitrage pro fi ts by borrowing at 4% and investing in synthetic one-year pure discount bonds consisting of a share of stock, a European put with exercise price $100 , and a short position in a European call with an exercise price $100 . The synthetic bond would cost $95 and pay o ff $100 at maturity in one year. The principal and interest on the $95 it costs to buy this synthetic bond would be $94 × 1 . 04 = $98 . 8 . Thus, there would be a pure arbitrage pro fi
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern