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Set up an arbitrage strategy

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a. A four-month European call option on a dividend-paying stock is currently selling for $4. The stock price is $64, the strike price is $60, and a dividend of $0.80 is expected in one month. The risk-free rate is 12% p.a. for all maturities.

i. Show that the call price is below the lower bound.

ii. Set up an arbitrage strategy and show the arbitrage profit at maturity for ST ≤60 and ST>60.

b. A stock price is currently $20, and it is known that at the end of six months it will be either $24 or $16. The risk-free rate is 2% p.a. with continuous compounding. Using the hedging argument, what is the value of a six month European put option with strike price of $20?

Reference no: EM133058536

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