Arbitrage

[notjusttp]

Hi David,

Kindly let me know how to solve this question ( Hull question 1.25 )

Suppost that $ sterling spot and fwd xchange rates r as follows

Spot 2.0080
90 day fwd 2.0056
180 day fwd 2.0018

What oppurtunities are open to arbitrageur in following situations

a) A 180 day european call option to buy sterling 1 for $1.97 costs 2 cents
b) A 90 day european put option to sell sterling 1 for $2.04 costs 2 cents

Thanks & rgds
Amit

 

[notjusttp]

Hi David,

Any update??

rgds
Amit

 

[David Harper CFA FRM]

Hi Amit,

I entered the problem into a worksheet, see (image below)
http://sheet.zoho.com/public/btzoho/hull-01-25

I didn't collect this question, right? Let me know if you think it's an instructive (good) question b/c I am not sure i see the point (it doesn't test IRP, eg.)...I guess the point is to see that the "all in" cost of the call option (1.57 + .02) is less than the forward (1.6018) so you will lock in at least that profit; i.e., 1.6018 - (1.57 + .02) = min profit ... as you can see by the scenarios...David

http://learn.bionicturtle.com/images/forum/hull.01.25.png

 

[notjusttp]

Hi David,\

You are correct. This question does not seem to cover any testable concepts. I just stuggled with it while going thru hull...tks for your clarification..Cheers..Amit