In a Two-Period Binomial World,a Mispriced Call Will Lead to an Arbitrage

question 12

Multiple Choice

In a two-period binomial world,a mispriced call will lead to an arbitrage profit if

• A)the proper hedge ratio is maintained over the two periods
• B)the hedge portfolio is terminated after one period
• C)the option goes from over- to underpriced or vice versa
• D)the option remains mispriced over both periods
• E)none of the above

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Definitions:

Mixed Numbers

Numbers consisting of an integer and a proper fraction, representing a value between two whole numbers.

Lowest Terms

A fraction that cannot be reduced by any common divisor.

Fractions

Number expressions of one or more equal parts of whole units.

Improper Fractions

Improper fractions are fractions where the numerator (the top number) is greater than or equal to the denominator (the bottom number), representing a value equal to or greater than one.