A European call option has a strike price of $20 and an expiration date in six months. The premium for the call option is $5. The current stock price is $25. The risk-free rate is 2% per annum with continuous compounding. What is the payoff to the portfolio, short selling the stock, lending $19.80 and buying a call option? (Hint: fill in the table below.)
Value of ST
Payoff
ST ⤠20
ST > 20
How much do you pay for (or receive with) this portfolio at date 0?
Is there an arbitrage opportunity?
If there is an arbitrage opportunity, then answer the following:
What is the minimum profit, expressed as a present value?
Will investors trade to exploit the opportunity?
If they will trade to exploit the opportunity, explain why security prices change and describe how security prices change.
A European call option has a strike price of $20 and an expiration date in six months. The premium for the call option is $5. The current stock price is $25. The risk-free rate is 2% per annum with continuous compounding. What is the payoff to the portfolio, short selling the stock, lending $19.80 and buying a call option? (Hint: fill in the table below.)
| Value of ST | Payoff |
| ST ⤠20 | |
| ST > 20 |
How much do you pay for (or receive with) this portfolio at date 0?
Is there an arbitrage opportunity?
If there is an arbitrage opportunity, then answer the following:
What is the minimum profit, expressed as a present value?
Will investors trade to exploit the opportunity?
If they will trade to exploit the opportunity, explain why security prices change and describe how security prices change.
