9. When the yield curve is steep for short maturities it is possible to get some
ID: 2725983 • Letter: 9
Question
9. When the yield curve is steep for short maturities it is possible to get some interesting dislocations between the equity options markets and the fixed income markets. (a) (5 pts) If an 3-month at-the-money european call option on a USD 35.00 stock is trading at USD 3.05 and put option with the same exercise features and expiration date is trading at USD 2.79 what should the annual continuously-compounded interest rate be in the absence of arbitrage? (b) (5 pts) If the interest rate posted by your broker (bank) is 3.25%/year, what trades would you do now to capitalize on this discrepancy? (c) (3 pts) Given your portfolio in question (9b), what happens if your broker goes bankrupt before option expiration?Explanation / Answer
according to call put parity theory
S+P=C+X(1+r)-n
where S is current stock price P is put premium C is call premium and X is strike price
35+2.79=3.05+35(1+r)-.25
r =3%
b)If our broker offering 3.25% we should short a stock and put and buy a call and net money received should be lent to broker at 3.25%
c) if brokers happen to be bankrupt we have to suffer loss of money invested with him
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