XYZ stock is currently trading at $100. The one-year effective interest rate is 5% ($1 lent today yields $1.05 one year from now). A one year put with strike price $105 is priced at $5.
- Suppose you buy one put for $5, buy one share for $100, and borrow $100. Graph the PAYOFF function for this position (i.e., 1 put + 1 share + $100 borrowing). Be sure to label the points, if any, where the graph intercepts the x-axis or y-axis.
- What common derivative is the combination of investments (put+share+ borrowing) equivalent to? In the absence of arbitrage, what should be the price of this derivative if it were available?
Download Full Solution