MBA 676: Securities Analysis, Derivatives and Portfolio Management Max points 10

Assignment #3: Due Date October 28, 2014 11:59 PM

Note: (A) You will lose 2 points for late submission. (B) Please provide complete reference of the
sources, used to solve the problems.

1. Let us assume that the dividends that will be paid during the life of an option are known, and D denotes
the present value of the dividends during the life of the option. Then show that for European call and put
options with same strike price and maturity, the put-call parity is given by,

+ +

= +
0

(2 points)
2. Consider a stock whose current value is `40. Its expected return and volatility parameters are given by,
14% and 20%, respectively. In Excel, simulate the stock price path over 5 years using monthly time steps
and random samples from a normal distribution. Produce the chart of simulated stock price paths. (2
points)
3. Consider Butterfly spreads created using put options, with strike prices
1
,
2
,
3
such that,
1
<
2
<

3
, and the prices of put options are given by
1
,
2
and
3
, respectively. Then show that

2
0.5
1
+
3

(2 points)
4. The stock price is currently `50. An analyst wants to value 2-year stock option using the binomial
model. The stock will either increase in value by 10% or fall in value by 10%. The annual risk-free rate is
8% per annum with continuous compounding, and no dividends are paid. (4 points)
a. Calculate the value of a European call option with an exercise price of `55.
b. Calculate the value of a European put option with an exercise price of `55.
c. Confirm that your solutions for the values of call and the put satisfy put-call parity.
d. If the put options were American, would it ever be optimal to exercise it early at any of the nodes on
the tree ?