A Stock Priced at $65 Has a Standard Deviation of 30

question 14

Multiple Choice

A stock priced at $65 has a standard deviation of 30%. Three month calls and puts with an exercise price of $60 are available. The calls have a premium of $7.27 and the puts cost $1.10. The risk free rate is 5%. Since the theoretical value of the put is $1.525, you believe the puts are undervalued.
-If you wished to construct a riskless arbitrage to exploit the mispriced puts you should ____________.

• A) buy the call and sell the put
• B) write the call and buy the put
• C) write the call and buy the put and buy the stock and borrow the present value of the exercise price
• D) buy the call and buy the put and short the stock and lend the present value of the exercise price

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Definitions:

Operating Characteristic

A function or curve that describes the discerning capacity of a statistical test, defining the probabilities of accepting a hypothesis over a range of values.

Sample Size

The number of individuals or observations used in a study, affecting its power and the precision of the results.

Type II Error

A statistical error that occurs when a false null hypothesis is not rejected, missing an actual effect or difference.

Sample Size

The number of observations or data points in a statistical sample.