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MANG 6020 Financial Risk ManagementSeminar 4
Question 1
Suppose that a European call option to buy a share for $100.00 costs $5.00 and is held until
maturity. Under what circumstances will the holder of the option make a profit? Under what
circumstances will the option be exercised? Draw a diagram illustrating how the profit from a
long position in the option depends on the stock price at maturity of the option.
Question 2
Suppose that a European put option to sell a share for $60 costs $8 and is held until maturity.
Under what circumstances will the seller of the option (the party with the short position) make a
profit? Under what circumstances will the option be exercised? Draw a diagram illustrating how
the profit from a short position in the option depends on the stock price at maturity of the option.
Question 3
A one-month European put option on a non-dividend-paying stock is currently selling for $2.50.
The stock price is $47, the strike price is $50, and the risk-free interest rate is 6% per annum.
What opportunities are there for an arbitrageur?
Question 4:
A trader buys a call option with a strike price of $45 and a put option with a strike price of $40.
Both options have the same maturity. The call costs $3 and the put costs $4. Draw a diagram
showing the variation of the trader’s profit with the asset price.
Question 5:
Suppose that put options on a stock with strike prices $30 and $35 cost $4 and $7, respectively.
How can the options be used to create (a) a bull spread and (b) a bear spread? Construct a table
that shows the profit and payoff for both spreads.
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