Derivatives markets solution manual

McDonald, Northwestern University. If You're an Educator Download instructor resources Additional order info. Overview Order Downloadable Resources Overview. Download Resources. Previous editions. Relevant Courses. Derivatives Finance. As wehavetheoppositeside,wewillnever mak e an y mone y at the ex pirati on of the put option. Ourprofitisrestrictedtothe futur e value of th e p remi um, and w e mak e th is maximumprofit wheneverthestockpriceat ex pirati on is greate r than the strike price.

However,welose moneywheneverthe st ock price is smaller tha n the strike ; hence,thelargestlossoccurs whenthe stock pric e att a ins it s smallest possi ble value, z ero. W e lose the st rike price b ec ause somebodysellsusanassetforthe strike th at is w orth nothi ng. W e ar e onl y compensatedby thefuturevalueofthepr emi um we rec eived. W e can now graph th e p a yo ff and p rofit dia gram s for the call opti ons.

Th e pa yoff di a gram looks as follows:. W e get the p rofit dia gra m b y dedu cti ng the opti on premi a from the p a yoff gr aphs. The p rofit diagr am l ooks as follows :. How ever, ther e are some inst ances in which the strike opti on pa ys o ff and the 45 -strike op ti on does not. S im il arly, th ere a re some inst ances in which the 35 -strike opti on pa ys o ff bu t neit her the 40 -strike nor the 45 -s trikepay off. Therefore,thestrike offe rs more potential than the 40 - and 45 -strike,andthe40strikeoffersmore potential than the strike.

W e pa y fo r theseadditionalpayoff possibilitiesby ini ti all y p a yin g a high er pr emi um. W e get the p rofit dia gra m b y dedu cti ng the opti on premi a from the p a yoff graphs. Th e profit diagr am l ooks as follows :. Intui ti vel y, when ever the 35 -strike put opti on pa ys off i.

H owever, ther e ar e some inst ances in which the strike opti on pa ys off and the 35 -strike opti on does not. S im ilarl y, there are some instancesin whichthestrikeoptionpays off but neit her the 40 -strike nor th e 35 -stri kepayoff. Therefore, thestrikeoffers mor e potential than th e 40 - and 35 -strik e, and thestrikeoffersmore potentialthanthe 35 -strike.

W e pa y fo r these add it ional pa yoff possibilitiesbyinitiallypayinga higherp remi um. It m ake s sens e that the premi um is i ncreasin g in t he strike price. In other wo rds, the returnontheloan,therisk-freeint erest rate r , w as known toda y, and we removed uncertainty aboutthepaymenttobemade. Ifw e we re to fina nce the pur cha se o f the i ndex b y shortselling IBMstock,wewouldintroduce addit ional unce rta int y be cause the futur e v alueoftheIBMstock isunknown. Therefore, we could not calcul ate t oda y th e amount to be r epaid,anditwouldbe impossibletoestablis h an equivale nce betwe en the forward and loan - financedindexpurchase today.

Thec alculati on of a profit dia gr am woul d onl y be possibleifweassumedanarbitrary valuefor IBM at ex pirati on of the futures, and w e would have to dra w man y pro fit di a grams wi th. Millions discover their favorite reads on issuu every month. Give your content the digital home it deserves. Get it to any device in seconds. Publish for free today. Buy the call 2. Sell the put 3. Short the stock 4.

Lend the present value of the strike price plus dividend The existence of the bid-ask spread and the borrowing-lending rate dierence doesnt change the zero payo of the above position. The above position always has a zero payo whether theres a bid-ask spread or a dierence between the borrowing rate and the lending rate.

If there is no transaction cost such as a bid-ask spread, the initial gain of the above position is zero. However, if there is a bid-ask spread, then to avoid arbitrage, the initial gain of the above position should be zero or negative. We are told to ignore the transaction cost. In addition, we b are given that the current stock price is The dividend is 0.

To nd the expiration date, you need to know this detail. In CBOE, the expiration date of an equity option is the Saturday immediately following the third Friday of the expiration month. To verify this, go to www. Click on "Products" and read "Production Specications.

Then the expiration date is November Then the expiration date is January 22, Fortunately,we can use a calculator. ACT mode calculates the actual days between two dates. If you use the day mode, you are assuming that there are days between two dates. When using the date worksheet, set DT1 i.

Date 1 as October 10, by entering Date 2 as January 22, by entering 1. Sell the call 2. Borrow the present value of the strike price plus dividend 3. Buy the put 4. Buy one stock. If there is transaction cost such as the bid-ask spread, then to avoid arbitrage, the initial gain of the above position is zero. However, if there is a bid-ask spread, the initial gain of the above position can be zero or negative.

If we buy a strike call, buy a strike call, sell two strike calls A strike call and a strike call form a diversied portfolio of calls, which is always as good as two strike calls So the cost of buying a strike call and a strike call can never be less than the revenue of selling two strike calls What we pay if we buy a strike call and a strike call: 6.

I recommend that you dont bother memorizing textbook Equation 9. If we sell a strike call, sell a strike call, buy two strike calls A strike call and a strike call form a diversied portfolio of calls, which is always as good as two strike calls So the revenue of selling a strike call and a strike call should never be less than the cost of buying two strike calls.

What we get if we sell a strike call and a strike call: 6. Open navigation menu. Close suggestions Search Search. User Settings. Skip carousel. Carousel Previous. Carousel Next. What is Scribd? Explore Ebooks. Bestsellers Editors' Picks All Ebooks. Explore Audiobooks. Bestsellers Editors' Picks All audiobooks. Explore Magazines. Editors' Picks All magazines. Explore Podcasts All podcasts. Difficulty Beginner Intermediate Advanced. Explore Documents. Derivative Markets Solutions'.

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Jump to Page. Search inside document. Buy one stock If there is transaction cost such as the bid-ask spread, then to avoid arbitrage, the initial gain of the above position is zero. Tiffany Holland. Sidharth Choudhary. Thuhoai Nguyen. Jess Ling. Loh Hui Yin. Wei Seong. Jose Martinez-Gracida. Steven Lai.

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