Suppose a stock can be purchased for $8, a put option on the stock can be purchased for $1.50, and a call option on the stock can be written (i.e., sold) for $1.00. If holding these positions in combination can guarantee a payoff of $10 at the end of the year, then what must be the risk-free rate if no arbitrage opportunities exist?
A) 12.50%.
B) 5.50%.
C) 17.65%.
D) 33.33%.
E) 18.75%.

Question

Quizplus · Accepted Answer

The net cost of the portfolio is $8 (stock) + $1.50 (put) - $1.00 (call) = $8.50. The guaranteed payoff is $10. The risk-free rate is calculated as ($10 / $8.50) - 1 = 17.65%.

Suppose a Stock Can Be Purchased for $8, a Put