Question

In: Finance

— The stock’s price S is $100. After three months, it either goes up and gets...

— The stock’s price S is $100. After three months, it either goes up and gets multiplied by the factor U = 1.13847256, or it goes down and gets multiplied by the factor D = 0.88664332. — Options mature after T = 0.5 year and have a strike price of K = $105. — The continuously compounded risk-free interest rate r is 5 percent per year. — Today’s European call price is c and the put price is p. Call prices after one period are denoted by cU in the up node and cD in the down node. Call prices after two periods are denoted by cUD in the “up, and then down node” and so on. Put prices are similarly defined. Suppose a trader quotes a call price of $4.50. Then, you can make an immediate arbitrage profit of:

Group of answer choices

$7.66 by selling the synthetic call and buying the market-quoted call

$1.50 by buying the synthetic call and selling the market-quoted call

$7.66 by buying the synthetic call and selling the market-quoted call

$1.50 by selling the synthetic call and buying the market-quoted call

please provide explanation

Solutions

Expert Solution

FEEL FREE TO ASK ANY DOUBTS. THUMBS UP PLEASE.

Answer:$1.50 by selling the synthetic call and buying the market-quoted call

Market price = 4.50

Should be price = 6

Profit=6-4.50=1.50

Since Market Price is Cheap buy it & Sell the synthetic call.


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