Question

In: Finance

A stock is currently priced at $40. The risk-free rate of interest is 8% p.a. compounded...

A stock is currently priced at $40. The risk-free rate of interest is 8% p.a. compounded continuously and an 18-month maturity forward contract on the stock is currently traded in the market at $38. You suspect an arbitrage opportunity exists. Which one of the following transactions do you need to undertake at time t = 0 to arbitrage based on the given information?

a)Long the forward, borrow money and buy the share

b)Short the forward, short-sell the share and invest at risk-free rate

c)Long the forward, short-sell the share and invest at risk-free rate

d)Short the forward, borrow money and buy the share

Solutions

Expert Solution

formula for arbitrage free futures price is

F = s×e^rt

Where s is spot rate

R is rate

= 40×e^(0.08)×1.5 = 45

But actual price is 38

as the actual rate is less than arbitrage free rate arbitrage oppurtunity exixts

And arbitrage process is

Long forward short sell the spot market and invest at risk free rate

Option 3 is correct


Related Solutions

A stock currently trades at $40. The continuously compounded risk-free rate of interest is 7%, and...
A stock currently trades at $40. The continuously compounded risk-free rate of interest is 7%, and the volatility of the stock return is 35%. Use the Black-Scholes formula to compute each of the following (round each answer to the nearest penny). a) The price of a 0.25-year European call option, struck at $45. Price = $ . ------------------- b) The price of a 0.25-year European put option, struck at $45. Price = $ .----------------------
A stock is currently priced at $37.00. The risk free rate is 5% per annum with...
A stock is currently priced at $37.00. The risk free rate is 5% per annum with continuous compounding. In 7 months, its price will be either $42.18 or $31.82. Using the binomial tree model, compute the price of a 7 month bear spread made of European puts with strike prices $41.00 and $45.00.
A stock is currently priced at $35.00. The risk free rate is 3.2% per annum with...
A stock is currently priced at $35.00. The risk free rate is 3.2% per annum with continuous compounding. In 4 months, its price will be either $39.90 or $31.15. Consider the portfolio with the following: long a European call with strike $39.00 expiring in 4 months; a short futures position on the stock with delivery date in 4 months and delivery price $40.00; a derivative which pays, in 4 months, three times the price of the stock at that time....
A stock is currently priced at $77.00. The risk free rate is 3.2% per annum with...
A stock is currently priced at $77.00. The risk free rate is 3.2% per annum with continuous compounding. Use a one-time step Cox-Ross-Rubenstein model for the price of the stock in 15 months assuming the stock has annual volatility of 19.4%. Compute the price of a 15 month call option on the stock with strike $81.00.
A stock is currently priced at $49.00. The risk free rate is 5.9% per annum with...
A stock is currently priced at $49.00. The risk free rate is 5.9% per annum with continuous compounding. In 8 months, its price will be $57.33 with probability 0.46 or $42.63 with probability 0.54. Using the binomial tree model, compute the present value of your expected profit if you buy a 8 month European call with strike price $53.00. Recall that profit can be negative.
he current price of a non-dividend paying stock is 40 and the continuously compounded risk-free interest...
he current price of a non-dividend paying stock is 40 and the continuously compounded risk-free interest rate is 4%. The following table gives call and put option premiums for three-month European-style options of various exercise prices. Exercise price Call Premium Put premium 35 5.75 0.40 40 2.29 1.90 45 0.50 5.05 A trader interested in speculating on volatility is considering two investment strategies. The first is a long 40-strike straddle. The second is a long strangle consisting of a long...
Stock ABC is currently trading at $22.31. The annualized risk-free rate is 6%, compounded monthly, and...
Stock ABC is currently trading at $22.31. The annualized risk-free rate is 6%, compounded monthly, and the stock's annualized dividend yield is 5%. You want to buy a 9-month put option. What is the strike price of the 6-month option that is at-the-money?
Suppose a stock is priced at $ 40 at expiry and the annual interest rate is...
Suppose a stock is priced at $ 40 at expiry and the annual interest rate is 12 %. Determine the profit at expiry for the following one-year European call options: a)A $ 35-strike call with premium $ 9.94 b)A $ 45-strike call with premium $ 4.73
It is now the end of Dec 2020. Risk-free interest rate is 10% p.a. for all...
It is now the end of Dec 2020. Risk-free interest rate is 10% p.a. for all maturities (continuous compounding). Entries in the table below (in italics) represent European put option prices on the stock of FGH. The current stock price of FGH is $21.00. FGH does not pay dividends. Exercise price of European Put Option prices Expiry: End March 2021 Expiry: End June 2021 K=$21 $5.50 Not traded K=$25 $5.00 Not traded K=$30 Not traded $7.25 Note K=Exercise price Is...
Assume no arbitrage unless otherwise noted. A stock is currently priced at $39.00. The risk free...
Assume no arbitrage unless otherwise noted. A stock is currently priced at $39.00. The risk free rate is 4.9% per annum with continuous compounding. Every 6 months, its price will either go up by 17% or down by 19%. Consider a European put with strike $42.00 expiring in 12 months. (a) Using the binomial tree model, compute the price of a European put option at the initial node, the two intermediate nodes, and the three terminal nodes. Enter the following...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT