Finding Arbitrage Opportunity
Not what you're looking for?
Suppose that the premium on a European put option, p = $3. The time to maturity, T = 1 year. The strike price is $20. The stock price of the underlying common stock is $12 today. The risk-free interest rate is 8% per annum. The stock does not pay dividends.
Observe that there is an arbitrage opportunity.
Clearly state what the trader would do to make a profit.
Make sure that you demonstrate the relation that must be satisfied to eliminate the arbitrage opportunity
Purchase this Solution
Solution Summary
Finding Arbitrage Opportunity
Solution Preview
First, we note the following:
- we can buy a put for $3
- we can buy a share of the stock for $12
- we spent $15 in total
- we are guaranteed to sell the share for $20 a year later.
Here is the arbitrage strategy:
- Borrow $15 on money market
- Buy a share of the stock and a put option with that $15.
- A year later, sell the share for $20 (using the put).
- The loan a year later will be 15 X 1.08 = $16.2
- The trader made $3.8.
When and how will the arbitrage opportunity be ...
Purchase this Solution
Free BrainMass Quizzes
Change and Resistance within Organizations
This quiz intended to help students understand change and resistance in organizations
Social Media: Pinterest
This quiz introduces basic concepts of Pinterest social media
Marketing Research and Forecasting
The following quiz will assess your ability to identify steps in the marketing research process. Understanding this information will provide fundamental knowledge related to marketing research.
Business Ethics Awareness Strategy
This quiz is designed to assess your current ability for determining the characteristics of ethical behavior. It is essential that leaders, managers, and employees are able to distinguish between positive and negative ethical behavior. The quicker you assess a person's ethical tendency, the awareness empowers you to develop a strategy on how to interact with them.
Basic Social Media Concepts
The quiz will test your knowledge on basic social media concepts.