Please provide the answer attached only! Step by step. You, the 17742

| November 13, 2015

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1). A European call option has a strike price of $20 and an expiration date in six months. The

premium for the call option is $5. The current stock price is $25. The risk-free rate is 2% per

annum with continuous compounding. What is the payoff to the portfolio, short selling the stock,

lending $19.80 and buying a call option? (Hint: fill in the table below.)

Value of ST

Payoff

ST ≤ 20

ST > 20

How much do you pay for (or receive with) this portfolio at date 0? Is there an arbitrage

opportunity?

If there is an arbitrage opportunity, then answer the following:

What is the minimum profit, expressed as a present value? Will investors trade to exploit the

opportunity? If they will trade to exploit the opportunity, explain why security prices change and

describe how security prices change.

Make sure you answer all parts of this question.

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