FM212 MT2014 Problem Set Solutions
5. Class 8
22. From the Put-Call Parity we can derive the implied interest rate:
a. P+S=C+EX/(1+r) solving for r=0 monthly rate
b. Payoff and profit diagrams
Pay off and Profit Dia gram
-200
-150
-100
-50
0
50
100
150
200
0 50 100 150 200 250
Stock Price
Payoff/Profit
Pay off long call Profit long call Pay off short c all Profit short c all
Payoff an d Profit Diagram
-150
-100
-50
0
50
100
150
0 50 100 150 200 250
Stock Price
Payoff/Profi t
Pay off long put P rofit long p ut Payoff s hort put P rofit short put
23. Consider each company in turn, making use of the put-call parity relationship:
Value of call + Present value of exercise price = Value of put + Share price
Furbish Lousewort. Here, the left-hand side [$15 + ($100/1.1
1/2
) = $110.35] is greater
than the right-hand side [$10 + $90 = $100]. Therefore, there is a significant mispricing.
To take advantage of this situation, one should buy the put, buy the stock, borrow $95.35
(present value of exercise price) at the risk-free rate, and sell the call.
