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BUS333 Derivative Securities

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A European call option and put option on a stock both have a strike price of $10 and an expiration date in three months. The call option sells for $1.00 and the put has a premium of $1.50. The risk free rate is 10% per annum (continuously compounded), and the current stock price is $9.50. Outline the procedure for a trader to exploit any arbitrage opportunity that is present.   2 2. A stock is currently priced at $20. It is known that at the end of four months it will be either $18 or $22. A four-month European call option on this stock with a strike price of $20.50 is available, while the risk-free interest rate is 5% p.a. (continuously compounded). i) What is the composition of the riskless portfolio? ii) Use no-arbitrage arguments to determine the value of the call option. 3. Explain why Black’s approximation for valuing an American call option on a dividend paying stock work

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