Finance (Derivative Securities) Version 1 D r. Kurt Smith Page 1 ASSIGNMENT 2 [15 marks] Instructions This assignment must be your own work. Answer all questions. This assignment is worth a total of fifteen [15] marks. The deadline for submission is Friday, 24th May 2013, at 12:00. Submit your assignment in accordance with the submission details on Blackboard. This assignment is based entirely on material that you have already covered. Question 1 [5 marks] The underlier is trading at a spot price of $100. The ten year riskless interest rate is trading at 10% p.a., continuously compounded. What is the strike price that makes the value of a European vanilla Call option on the underlier with a maturity of ten years equal to the value of a European vanilla Put option on the underlier with a maturity of ten years? Show all working. [5 marks] Question 2 [5 marks] Two European vanilla Call options on the same underlier and with the same maturity are trading in the market. Option 1 has strike price K1 and is trading at $1.00, Option 2 has strike price K2 and is trading at $0.75. Option 3 is a European option on the same underlier and with the same maturity as the vanilla options. It is trading in the market at $0.15, and it has the expiry payoff shown below (a payoff of $1 is received by the buyer if the underlier is trading greater than or equal to K2 on expiry and zero otherwise): (i) Use the three options to construct a European option with expiry payoff shown below. Complete a table like the one below to show the details of the replication portfolio. Please show all working (diagrammatic workings are acceptable provided strike prices and the y-intercept are clearly shown on your diagram(s)). [3 marks] K2-K1 Strike Price Expiry Payoff K2 Strike Price Expiry Payoff 1
Finance (Derivative Securities) Version 1 D r. Kurt Smith Page 2 Portfolio Buy or Sell? Amount? Mark Option 1 [1 mark] Option 2 [1 mark] Option 3 [1 mark] (ii) What is the no-arbitrage value of the European…