Continuously compounded annual risk-free rate


Problem:

Suppose ABC stock currently is trading at $60 per share, has an annualized standard deviation of .35, and will not pay any dividends over the next three months; suppose that the continuously compounded annual risk-free rate is 6%.

Required:

Question 1: Using the Black-Scholes OPM, calculate the equilibrium price for a three-month ABC 60 European call option

Question 2: Using the Black-Scholes OPM, calculate the equilibrium price for a three-month ABC 60 European put option

Question 3: Show the Black-Scholes put price is the same price obtained using the put-call parity model.

Question 4: Describe the arbitrage strategy you would pursue if the ABC 60 call was overpriced and if it was underpriced.

Question 5: What would be the new equilibrium prices of the ABC call and put if ABC stock increased to $60.50?

Note: Show all workings.

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Accounting Basics: Continuously compounded annual risk-free rate
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