Use the Following Data for a Single-Period Binomial Model to Answer

question 10

Multiple Choice

Use the following data for a single-period binomial model to answer the questions that follow.
- The stock's price S is $50.After three months,it either goes up by the factor U = 1.16038286 or it goes down by the factor D = 0.85963276.
- Options mature after T =0 0.25 years.
- The continuously compounded risk-free interest rate r is 4 percent per year.
-Given the above data,consider an exotic option whose payoff at expiration is given by the stock price S(1) squared less a strike price (K= $2,500) if it has a positive value,zero otherwise,that is: max[S(1) ²- 2500,0].
Suppose a trader quotes a price of $450 for this option.Then you can make an immediate arbitrage profit of:

• A) $21.08 by selling the traded call and buying the synthetic call involving buying 57.60 shares of stock and selling 2,451.28 units of the money market account
• B) $226.50 by buying the traded call and selling the synthetic call involving selling 90.85 shares of stock and buying 3,866.21 units of the money market account
• C) $50 by buying the traded call and selling the synthetic call involving selling 60.54 shares of stock and buying 2,321.21 units of the money market account
• D) $337.76 by selling the traded call and buying the synthetic call involving buying 16.74 shares of stock and selling 641.35 units of the money market account
• E) None of these answers are correct.

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Definitions:

Outstanding Debts

Financial obligations or amounts owed by a person or entity that are yet to be paid.

Creditors

Individuals, companies, or institutions to whom money is owed by debtors for goods or services that have been provided but not yet paid for.

Purchase of Assets

involves acquiring assets of a company rather than its stock, usually in the context of mergers and acquisitions, focusing on buying specific assets like equipment, inventories, and property.

TradeMarks

Symbols, words, or phrases legally registered or established by use as representing a company or product.