CHAPTER 20

Thereforethecashflowsarepositivenowandzeroorpositiveon

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Unformatted text preview: r than or less than the exercise price. If the stock price is greater than $50, then you would exercise the call (using the cash from the bank deposit) and buy back the stock. If the stock price is less than $50, then you would let the call expire and buy back the stock. The cash flow at maturity is the greater of zero (if the stock price is greater than $50) or [$50 – stock price] (if the stock price is less than $50). Therefore, the cash flows are positive now and zero or positive one year from now. 5. Let P3 = the value of the three month put, C3 = the value of the three month call, S = the market value of a share of stock, and EX = the exercise price of the options. Then, from put­call parity: C3 + [EX/(1 + r)0.25] = P3 + S Since both options have an exercise price of $60 and both are worth $10, then: EX/(1 + r)0.25 = S From put­call parity for the six­month options, we have: C6 + [EX/(1 + r)0.50] = P6 + S Since S = EX/(1 + r)0.25, and EX/(1 + r)0.50 is less than EX/(1 + r)0.25, then the valu...
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