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# Parity Relationships and Arbitrage

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6. Round Rock National Bank lent \$1,000,000 to Block Watne Homes, with very substantial
collateral, at a floating rate pegged at 2% above the T-Bill rate. The Bank borrowed
\$1,000,000 in Eurodollars from HSBC Bank in England, at 1% over LIBOR (London
Interbank Offered Rate). Round Rock National's correspondent, Citicorp, offered to
arrange a swap with \$1,000,000 principal that would allow Round Rock to receive interest
at 1% over LIBOR and pay at 1% over T-bill. Is the swap attractive to Round Rock
National?

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\$2.19

## Put-Call Parity, Options and Arbitrage

Question 1
What is put-call parity and why does it hold? Please show your proof?

Question 2
The following prices are observed. How are you going to profit from the opportunity?

Stock A is selling for \$95.00
Call options on stock A with exercise price of 90 and with April expiration are selling for \$9 per share
Put options on stock A with exercise price of 90 and with April expiration are selling at \$2.5 per share
At the current t-bill rate, \$89 invested today will grow to 90 at the option's maturity date.

Question 3
The following prices are observed. Use an arbitrage strategy to get an arbitrage profit.

Stock A is selling for \$95.
Call options on stock A with an exercise price of 85 is selling for \$12 per share
Call options on stock A with an exercise price of 90 is selling for \$10 per share
Put options on stock A with an exercise price of 85 is selling for \$1.25 per share
Put options on stock A with an exercise price of 90 is selling for \$1.75 per share
At the current t-bill rate, \$89 invested today will grow to 90 at the option's maturity date and 84.06 invested today will grow to 85 at the option's maturity date.

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