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Tony Smith believes that the price of a particular underlying, currently selling at $96, will increase substantially in the next six months, so he purchases a European call option expiring in six months on this underlying. The call option has an exercise price of $98 and sells for $4.
a) How much is the current credit risk, if any? (Hint: European option can be exercised only at the expiration date of the option.)
b) How much is the current value of the potential credit risk, if any?
c) Which party bears the credit risk(s), Tony Smith or the seller?
Mary is going to receive a 30-year annuity of $10,500. Nancy is going to receive perpetuity of $10,500. If the appropriate interest rate is 7 percent, how much more is Nancy’s cash flow worth?
Evaluate the project in light of this new information
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