Financial Economics

| December 19, 2015

1)

Suppose you sell a forward contract at $105 and buy the underlying asset at $89. You borrow cash to buy the underlying asset, paying 10%

(annual rate). The asset produces a cash flow of 2% (that is, 2% of the cash price of the underlying asset) that is paid at the end of one

year. What is the arbitrage profit from this cash-and-carry trade? Is the $105 price of the contract an equilibrium price (i.e. can it

last)? What is the theoretical forward price of the asset assuming one can borrow or lend at the same risk-free rate of 10%?

2)

Shares of MegaKimmel, a producer and marketer of caraway seeds, is selling for $50. A European-style call option with a strike price of

$55 and a maturity of three months is selling at $2. Assume the continuously compounding risk-free annual rate is 5%.

a) What should a European-style put option sell for if it has the same strike price and maturity?

b) If the call-price is undervalued, will the put price be undervalued or overvalued?

c) What is meant by put-call parity?

Category: Essay

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