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# How would you take advantage of this great opportunity? Now suppose the option is a European call. What would you do?

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4 Questions for you to familiarize with option and warrants, especially the Call/Put Parity, formula and relations.

Question 1
Pintail's stock price is currently \$200. A one-year American call option has an exercise price of \$50 and is priced at \$75. How would you take advantage of this great opportunity? Now suppose the option is a European call. What would you do?

Question 2
In June 2001 a six-month call on Intel stock, with an exercise price of \$22.50, sold for \$12.30. The stock price was \$27.27. The risk-free interest rate was 3.9 percent. How much would you be willing to pay for a put on Intel stock with the same maturity and exercise price?

Question 3
Suppose that Mr. Colleoni borrows the present value of \$100, buys a six-month put
option on stock Y with an exercise price of \$150, and sells a six-month put option on Y with an exercise price of \$50. Suggest two other combinations of loans, options and the underlying stock that would give Mr. Colleoni the same payoffs.

Question 4
a.) If you can't sell a share short, you can achieve exactly the same final payoff by a combination of options and borrowing or lending. What is this combination?

b.) Now work out the mixture of stock and options that gives the same final
payoff as a risk-free loan.

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#### Solution Preview

Question 1
You would buy the American call for \$75, exercise the call immediately in
order to purchase a share of Pintail stock for \$50, and then sell the share of
Pintail stock for \$200. The net gain is: [\$200 - (\$75 + \$50)] = \$75.

If the call is a European call, you should buy the call, deposit in the bank an
amount equal to the present value of the exercise price, and sell the stock
short. This produces a current cash flow equal to: [\$200 - \$75 - (\$50/1 + r))].
At the maturity of the call, the action depends on whether the stock price is
greater than or less than the exercise price. If the stock price is greater than
\$50, then you would exercise the call (using ...

#### Solution Summary

Here is just a sample of what you will find in the solution:

"This implies that, in order to replicate a short sale of a share of stock, you would purchase a put, sell a call, and borrow the present value of the exercise price."

\$2.49