Reference no: EM133002246

1) The Canadian dollar today is worth $0.625 U.S. For one-year maturity, the continuously compounded risk-free of return in Canada is 3% and, in the U.S., it is 2%. A currency speculator believes that the Canadian dollar will increase in value to $0.650 U.S. one year from now. Formulate a strategy in which the speculator can receive a gain for a net investment of 0 if the speculator's belief turns out to be correct

2) An investor expects upcoming financial market news to cause a given stock price to change by the same margin in either direction (either up or down). Carefully explain the appropriateness of the Black-Scholes framework in valuing a 1-month option on the same stock.

3) Today's derivative market news shows a European put option on a certain stock has a strike price of 1, a time to maturity 1, and an implied volatility of 1. A European call option on the same stock has a strike price of 2 , a time to maturity of 2 , and an implied volatility of 2. Outline and explain the complete set of conditions under which there is an arbitrage opportunity open to a trader.

Should the trader be cautious about distributional assumptions of the underlying asset? Carefully explain the reasons for your answer.