57 views

Uploaded by Wenn Zhang

- Hw5 Mfe Au14 Solution
- Hw2 Mfe Au14 Solution
- Hw7 Mfe Au14 Solution
- Hw3 Mfe Au14 Solution
- Hw6 Mfe Au14 Solution
- Hw8 Mfe Au14 Solution
- Hw4 Mfe Au14 Solution
- Mfe Sample Questions Solutions Adv Derivatives
- Lectures on Stochastic Calculus With Applications to Finance
- Hw9 Mfe Au14 Solution
- Understanding Options
- Option Strategy
- Quiz3 ADM4354 Winter2014 Solutions2
- Call Put Options Model
- Stock_c
- Lesser Known Option Trading Strategies
- ption
- Derivative Security Question
- Service Marketing and CRM
- International Financial Management

You are on page 1of 5

SOLUTION TO HOMEWORK 1

Lesson 0: Review of derivative instruments

Lesson 1: Put-Call Parity

Problem 1

For a non-dividend paying stock, you are given:

(i) Its current price is 32.

(ii) A European call option on the stock with one year to expiration and strike price 26 costs 8.15.

(iii) The continuously compounded risk-free rate is 0.055.

Determine the premium of a 1-year European put option on the stock with strike 26.

Solution. We are given:

S = 32, T = 1, K = 26, C = 8.15, r = 0.055

We need to find P .

By PCP for non-dividend paying stock,

C(S, K, T ) P (S, K, T ) = S0 KerT

P (S, K, T ) = C(S, K, T ) S0 + KerT = 8.15 32 + 26e0.055 = 0.7586 0.76

Problem 2

A stock pays dividends proportionate to its value at rate . You are given:

(i) The stock price is 45.

(ii) The continuously compounded risk-free rate is 5%.

(iii) A 3-month European call option on the stock with strike 45 costs 4.20.

(iv) A 3-month European put option on the stock with strike 45 costs 3.81.

Determine .

Solution. We are given:

S = 45, r = 0.05, T = 0.25, K = 45, C = 4.20, P = 3.81

We need to find .

By PCP for a dividend paying stock with continuous dividends,

C(S, K, T ) P (S, K, T ) = S0 eT KerT

S0 eT = C(S, K, T ) P (S, K, T ) + KerT

C(S, K, T ) P (S, K, T ) + KerT

1

= ln

=

T

S0

1

4.20 3.81 + 45e0.050.25

=

ln

= 0.01505 1.51%

0.25

45

Problem 3

A stock has price 50. Dividends of 3 are payable every four months, with the next dividend payable

at the end of one month. You are given:

(i) The continuously compounded risk-free rate is 7%.

(ii) A 4-month European put option with strike 55 costs 7.49.

Determine the premium of a 4-month European call option on the stock with strike 55.

1

1

S = 50, T = , K = 55, P = 7.49, r = 0.07, t = , D = 3

3

12

We need to find C.

By PCP for a dividend paying stock with discrete dividends,

C(S, K, T ) P (S, K, T ) = S0 Dert KerT

1

= 0.7759 0.78

Problem 4

For 2 stocks, S1 and S2 :

(i) The price of S1 is 25.

(ii) S1 pays continuous dividends at a rate of 1%.

(iii) The price of S2 is 65.

(iv) S2 pays continuous dividends at a rate of 4%.

A 1-year call option to receive a share of S2 in exchange for 2.5 shares of S1 costs 3.50.

Determine the premium of a 1-year call option to receive 1 share of S1 in exchange for 0.4 shares of

S2 .

Solution. Recall that the definitions of calls and puts are mirror images. A put to sell S for Q is

the same as a call to purchase Q for S:

P (St , Qt , T t) = C(Qt , St , T t)

Thus, PCP for exchange options could be re-written as:

C(St , Qt , T t) C(Qt , St , T t) = St eS (T t) Qt eQ (T t)

Here S is the stock being received and Q is the stock being paid with.

In our case, we are receiving one share of stock S2 for 2.5 shares of stock S1 . Thus,

S = S2 = 65, Q = 2.5S1 = 2.5 25 = 62.5 and

C(S, Q, T ) = C(S2 , 2.5S1 , T ) = C(65, 62.5, 1) = 3.5

Then C(Q, S, T ) in the formula above is

C(Q, S, T ) = C(2.5S1 , S2 , T )

But to receive 2.5 shares of stock S1 for one share of stock S2 is equivalent to receiving one share of

1

= 0.4 shares of stock S2 and

stock S1 for 2.5

C(Q, S, T ) = C(2.5S1 , S2 , T ) = 2.5C(S1 , 0.4S2 , T ),

which is exactly what need to find.

We are given that

S = S2 = 0.04 and Q = S1 = 0.01

Therefore,

C(Q, S, T ) = C(S, Q, T ) SeS T + QeQ T

2.5C(S1 , 0.4S2 , 1) = 3.5 65e0.04 + 62.5e0.01 = 2.9268 C(S1 , 0.4S2 , 1) = 2.9268/2.5 1.17

Problem 5

You are given:

(i) The spot exchange rate is 1.7$/.

(ii) The continuously compounded risk-free rate in dollars is 6.3%.

Page 2 of 5

(iv) A 6-month dollar-denominated European put option on pounds with a strike of 1.7$/ costs

$0.04

Determine the premium in pounds of a 6-month pound-denominated European call option on dollars

1

with a strike of 1.7

/$.

Solution. We are given the information for domestic currency = dollars and foreign currency

= pounds. We have:

x0 = 1.7, T = 0.5, K = 1.7, Pd (x0 , K, T ) = 0.04, rd = 0.063, rf = 0.034

We need to find Cf x10 , K1 , T .

Note that Call-Put relationship in foreign and domestic currency:

1 1

1

, ,T =

Pd (x0 , K, T )

Cf

x0 K

Kx0

Hence,

Cf =

1

0.04 = 0.0138

1.7 1.7

Problem 6

For conditions in Problem 5, determine the premium in pounds of a 6-month pound-denominated

1

/$.

European put option on dollars with a strike of 1.7

Solution. Since we need to find a pound denominated value of a put, and weve already found a

pound denominated value of a call in the previous problem the domestic currency now is pounds

and the foreign currency is dollars. Also,

1

1

, K=

, rd = 0.034, rf = 0.063

1.7

1.7

By PCP for currency options with x0 as a spot exchange rate:

x0 =

Therefore,

P (x0 , K, T ) = C(x0 , K, T ) x0 erf T + Kerd T =

1 0.0630.5

1 0.0340.5

= 0.0138

e

+

e

= 0.0222 0.02

1.7

1.7

Problem 7

You are given:

(i) The spot exchange rate of yen for euros is 120U/e.

(ii) The continuously compounded risk-free rate for yen is 1.5%.

(iii) The continuously compounded risk-free rate for euros is 3%.

(iv) A one year yen-denominated call on euros costs U4.

(v) A one year yen-denominated put on euros with the same strike price as the call costs U3.

Determine the strike price in yen.

Solution.

In this Problem, the domestic currency is yen U and the foreign currency is euros e. We are

given:

x0 = 120, rd = 0.015, rf = 0.03, C = 4, P = 3

We need to determine K.

Page 3 of 5

C(x0 , K, T ) P (x0 , K, T ) = x0 erf T Kerd T

K = erd T P (x0 , K, T ) C(x0 , K, T ) + x0 erf T =

= e0.0151 3 4 + 120e0.03 = 117.1983 117.20

Problem 8

A European call option allows one to purchase 3 shares of Stock B with 1 share of stock A at the end

of a year. You are given:

(i) The continuously compounded risk-free rate is 4%.

(ii) Stock A pays dividends at a continuous rate of 3%.

(iii) Stock B pays dividends at a continuous rate of 2%.

(iv) The current price for Stock A is 80.

(v) The current price for Stock B is 35.

A European put option which allows one to sell 3 shares of Stock B for 1 share of Stock A costs 14.35.

Determine the premium of a European call option, which allows one to purchase 1 share of Stock A

for 3 shares of Stock B at the end of a year.

Solution. The option to receive 1 share of Stock A for 3 shares of stock B is the same as the option

to sell 3 shares of Stock B for 1 share of Stock A, which is the put option given in the problem. So

the premium for this call option is 14.35.

Problem 9

For a stock you are given:

(i) It pays semiannual dividends of 1.60.

(ii) It has just paid a dividend.

(iii) Its price is 77.

(iv) The continuously compounded risk-free interest rate is 5%.

Calculate the forward price for an agreement to deliver 200 shares of the stock fifteen months from

now.

Solution. We are given:

D = 1.6 paid at times t1 = 0.5, t2 = 1, S = 77, r = 0.05, T = 1.25

The forward price on a stock with discrete dividends is

F = SerT F V (D) = 77e0.051.25 1.6 e0.750.05 + e0.250.05 = 78.6848

To deliver 200 shares:

200F = 200 78.6848 = 15,736.96

Problem 10

A pound-denominated forward agreement provides for the delivery of e150 at the end of 9 months.

The continuously compounded risk-free rate for euros is 4%, and the continuously compounded riskfree rate for pounds is 2%. The current exchange rate is 0.9 /e.

Calculate the forward price in pounds for this agreement.

Solution. We are given: domestic = pounds, foreign=euros

T = 0.75, rf = 0.04, rd = 0.02, x0 = 0.9

Then the forward price to deliver on euro for pounds is

F = x0 e(rd rf )T = 0.9e(0.020.04)0.75 = 0.8866

Page 4 of 5

Page 5 of 5

- Hw5 Mfe Au14 SolutionUploaded byWenn Zhang
- Hw2 Mfe Au14 SolutionUploaded byWenn Zhang
- Hw7 Mfe Au14 SolutionUploaded byWenn Zhang
- Hw3 Mfe Au14 SolutionUploaded byWenn Zhang
- Hw6 Mfe Au14 SolutionUploaded byWenn Zhang
- Hw8 Mfe Au14 SolutionUploaded byWenn Zhang
- Hw4 Mfe Au14 SolutionUploaded byWenn Zhang
- Mfe Sample Questions Solutions Adv DerivativesUploaded byLetsogile Baloi
- Lectures on Stochastic Calculus With Applications to FinanceUploaded bythava477ceg
- Hw9 Mfe Au14 SolutionUploaded byWenn Zhang
- Understanding OptionsUploaded byedscribe
- Option StrategyUploaded byknightbtw
- Quiz3 ADM4354 Winter2014 Solutions2Uploaded byjennifer
- Call Put Options ModelUploaded byPrashant Kumar
- Stock_cUploaded byHenry Ho
- Lesser Known Option Trading StrategiesUploaded bywiggy223
- ptionUploaded byRandi Blythe
- Derivative Security QuestionUploaded bySharul Islam
- Service Marketing and CRMUploaded byNaveen Kalakat
- International Financial ManagementUploaded byifazkh
- ch19Uploaded bysumihosa
- Option derivative analysisUploaded bySanchit Mehrotra
- Copy of HW 4 - Module II Transaction ExposureUploaded byJoe
- Lecture 8(1)Uploaded byashraf53
- Solution of Homework 4Uploaded byKamalakar Reddy
- Presentation 1Uploaded byPrashanth Bhat
- Assignment 3 StudentUploaded byCarmen Alexandra Iamandii
- Chp07 Options MarketsUploaded byAmsalu Walelign
- Project ReportUploaded byAzaruddin Shaik B Positive
- Notes - Option PayoffsUploaded byBilal Ahmed

- Reasearch PaperUploaded bynidhiag1
- How Big is GE Capital_ It Depends - WSJUploaded bysjalum22
- Suggested Answer CAP III June 2017 GI (1)Uploaded byKimil Timilsina
- UFCE -Annex 1 &2Uploaded bySalil Nagvekar
- Hansjoerg Albrecher Andreas Binder Volkmar LaUploaded byAiz Dan
- Marriot Corporation Case SolutionUploaded bymanoj1jsr
- CoA Debit Credit TeoryUploaded bymipapirolivecom
- Stock ValuationUploaded byNor Hazliana
- Venture Capital StructureUploaded bytpself
- preface (1)Uploaded byKimeshan
- VC Unicorn Report - Good to Pitch to Very High Growth CompaniesUploaded byRishabh Bansal
- Paul Tudor Jones SpeechUploaded byTeh Yeow Yong
- Fina_mgmt 517 Exam i SampleUploaded bygeorge
- Mutual FundUploaded bybhavip_11
- AFX9590 Group Assignment 1Uploaded byMinhaz Ahmed
- Turbulent Times in Quant Land-RothmanUploaded byJay Kab
- Ey Pe Capital Briefing SeptUploaded bygreenpostit
- Assignment on Earning Management TechniquesUploaded byShahed Faisal
- Final Report 1Uploaded byKomal Gupta
- Basel-II Final_CBB.pptxUploaded byRajat Pani
- Post Fin301_fin 301 Unit 7 QuizUploaded byteacher.theacestud
- BANKING Finals QuestionsUploaded byDennice Erica David
- Kisi2 UAS AKM Terjawab.docUploaded byBakhtiar Alakadarnya
- Director Wealth Management Strategist in Greensboro Winston Salem NC Resume James SerambaUploaded byJamesSeramba
- 571 gold and stockUploaded bybharathandcompany
- Trader's Journal Cover - Brandon Wendell August 2010Uploaded bymleefx
- Comparison Between Beximco PharmaceuticalsUploaded byShovon
- AccesstoCapital_InvestmentBanksinSoCalUploaded byRobert Gu
- sbi (1).pdfUploaded bybhavana
- Capitulo 1-3 InvestmentbankingUploaded byTomy Ferreira