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Unformatted text preview: sentence explain the risk associated with this transaction. 2. Consider a market that has (a) a stock (also called a security or asset), current price S (b) a loan market so that money (also called a bond) can be borrowed or loaned at an annual interest rate of r compounded continuously. At the end of a time period T , the security will either increase in value by a factor U to SU , or decrease in value by a factor D to value SD . Show that a forward contract with strike price k that, is, a contract to buy the security at time T with potential values SU-k and SD-k should have the strike price set at S exp( rT ) to avoid an arbitrage opportunity. 1...
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- Fall '08
- Advanced Math