ACT370H1S - TEST 1 - FEBRUARY 14, 2007
Write name and student number on each page.
Write your solution for each
question in the space provided.
1. For each of the following payoff functions at time 1, find an appropriate combination of call
options and zero coupon bonds (short or long) that replicates the payoff.
3
a)
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W
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b)
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4
c)
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2.
A bull spread based on call options is the combination of a long call with strike price
and
O
"
a short call with strike price
, where
. Assume all options expire at time
.
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O
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X
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#
4
(a) Show that the payoff on a bull spread can also be obtained using an appropriate combination
of put options and zero coupon bond.
4
(b) Assuming European options and no dividends payable on the stock, use put-call parity to
prove that bull spread price at time 0 is the same when constructed with calls as it is when
constructed with the combination in part (a).