8006 Exam Dumps : Exam I: Finance Theory Financial Instruments Financial Markets - 2015 Edition

We know from the put-call parity that:

Call - Put = Stock - Deposit

In the given situation,

Stock price = 100

call = 35

Put = ?

Exercise price = 100

However, we cannot use the stock price as-is, we need to adjust it for dividends that will be received during the period for which the option is valid. Dividends are $1, which need to be discounted to the present. In financial theory, dividends are often assumed to be continuously paid, though in reality they are single discrete payments at points in time. In this situation, for simplicity we assume that the dividend is paid at the end of the year, and needs to be discounted to the present and deducted from the spot price.

Therefore:

Stock price adjusted for dividends = $100 - ($1/1.05) = $100 - $0.95 = $99.05

Similarly, the bank deposit amount, which is the PV of the exercise price, can be calculated as $100/1.05 = $95.24

We can now calculate the price of the put by plugging the numbers above in the put-call parity:

35 - Put = $99.05 - $95.24

Therefore the value of the put = 31.19, which is closest to 31.20 which therefore is the correct answer.

Consider a long vanilla call at a strike of K1, and a short call with a strike price of K2 so that K2>K1. If you construct the payoff diagrams for these option positions, you will see that the combined payoff resembles very closely the payoff of a digital cash-or-nothing option. By bringing K2 and K1 closer together, we can make it very close to a digital cash-or-nothing option. Therefore Choice 'c' is the correct answer.

The Sharpe ratio does not require investors to be risk neutral, only that for a given level of returns they prefer less risk to more risk. (Risk neutral means that investors are indifferent to the level of risk, and are only driven by a desire to maximizing expected value, regardless of risk levels.)

The ability to borrow and lend any amounts of money at the risk free rate is a fundamental assumption for the rule that optimal portfolios will maximize the Sharpe ratio.

This rule also assumes that risk preferences are completely described by return and standard deviation of returns.

Therefore Choice 'd' is the correct answer as statements I and II are correct.