A Stock Price (Which Pays No Dividends)is $50 and the Strike

question 5

Multiple Choice

A stock price (which pays no dividends) is $50 and the strike price of a two year European put option is $54.The risk-free rate is 3% (continuously compounded) .Which of the following is a lower bound for the option such that there are arbitrage opportunities if the price is below the lower bound and no arbitrage opportunities if it is above the lower bound?

• A) $4.00
• B) $3.86
• C) $2.86
• D) $0.86

---

Definitions:

Discount Rate

The discount rate applied in the discounted cash flow method to calculate the current value of future cash flows.

Tax Rate

The rate at which a person or company is charged taxes by the state.

Depreciation

The accounting method of allocating the cost of a tangible asset over its useful lifespan.

Opportunity Cost

The cost of forgoing the next best alternative when making a decision or investment.