Problem set #2 Solution - Problem Set 2 Solutions Econ 136,...

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

View Full Document Right Arrow Icon

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

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Problem Set 2 Solutions Econ 136, Fall 2009 A note about grading: 5: no major or minor errors 4: no more than a few minor errors 3: a major or many minor errors 2: multiple major errors 1: multiple major errors and portions left blank 0: blank or never turned in. 1. Puts and calls (a) Verify the put-call parity conditions, C + X 1+ R f = S + P , for the options with the following strike prices, X = { $22 , $24 , $26 } . Use bid prices for both put and call options, assume R f = 0 . 00, and S = 24 . 11. X C bid P bid C bid + X 1 . 00 24 . 11 + P bid Deviation from Parity 22 2.17 0.06 24.17 24.17 0.00 24 0.59 0.47 24.59 24.58 0.01 26 0.05 1.93 26.05 26.04 0.01 The last column is just the difference between the left and the right hand side of the parity equation C + X 1 + R f- ( S + P ) . Yes, there are deviations from parity. An arbitrage portfolio for the options with strike price $26 would include short selling the call option and lending $26, which would give you $26.05, then using the proceeds to buy the stock and buy a put option, which would cost a total of $26.04. For each contract this will allow you to earn a penny ($0.01) today with no gain or loss when the options expire. There are no gains or losses at expiration because you will be using the call option and the money in the bank to cover the put option and stock you shorted. (b) To check put-call parity, we used bid prices. If it does not hold, i.e. C + X/ (1+ R f ) 6 = S + P , then an arbitrage opportunity might exist. To take advantage of it, we should: sell (short) the expensive portfolio, buy the cheaper portfolio, and pocket the difference. Bid prices are prices at which the dealer is willing to buy a security and ask prices (or asked prices) are prices at which the dealer is willing to sell a security. The dealer is holding the opposite position from what you want to do. So if you want to sell, the dealer will buy from you, so you need to find the dealers bid prices....
View Full Document

Page1 / 4

Problem set #2 Solution - Problem Set 2 Solutions Econ 136,...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online