MATH262 Introduction to Financial Mathematics II

Homework 6 , Semester 2, 2017

Due date: Friday, March 17, 17:00 (sharp).

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Page 1 of 5
 MATH262 Introduction to Financial Mathematics II
Homework 6 , Semester 2, 2017

1. Suppose that the prices of European call and put options on a stock with an expiration date in
12 months and a strike price of 120 are 20 and 5, respectively. The current stock price is
130.

(a) What opportunities are there for arbitrageurs if the interest rate were different from your
answer for problem 2 of Homework 5?
(b) Calculate the profits of arbitrage portfolios if the interest rate were 3% and 8%.

Write your answer in the box provided and show any working below.

[10 marks]

Page 2 of 5
 MATH262 Introduction to Financial Mathematics II
Homework 6 , Semester 2, 2017

2. The price of a European call that expires in six months and has a strike price of 30 is 2.
The underlying stock price is 29, and two dividend payments of 0.50 are expected in 2 and
5 months. Interest rates for all maturities are 10% per annum compounded continuously.

(a) What is the price of a European put option that expires in six months and has a strike
price of 30?
(b) Describe an arbitrage opportunity if the price of a European put that expires in six months
were set at 3. Calculate its profit.

Write your answer in the box provided and show any working below.

[10 marks]

Page 3 of 5
 MATH262 Introduction to Financial Mathematics II
Homework 6 , Semester 2, 2017

3. Consider a four month call option on a stock when the stock price is 30, the strike price is
25, and the risk free interest rate is 8% per annum compounded continuously.

(a) What opportunities are there for arbitrageurs if the call option were priced at 3?
(b) What are the minimal and maximal prices of the call that would eliminate arbitrage
opportunities under these conditions?
(c) Would you be interested in the call if it were priced higher than 30. Explain.

Write your answer in the box provided and show any working below.

[10 marks]

Page 4 of 5
 MATH262 Introduction to Financial Mathematics II
Homework 6 , Semester 2, 2017

4. Consider a two month European put option on a non-dividend paying stock when the stock
price is 58, the strike price is 65, and the risk free interest rate is 5% per annum compounded
continuously.

(a) What opportunities are there for arbitrageurs if the put option were priced at 4?
(b) What are the minimal and maximal prices of the put that would eliminate arbitrage
opportunities under these conditions?
(c) Would you be interested in the put if it were priced higher than 63.40. Explain.

Write your answer in the box provided and show any working below.

[10 marks]

Page 5 of 5