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(1 point) An asset has value S = 60 at t = 0, and will have unknown value Sy at time T. A call option on the asset with strike K = 50 is currently (t = 0) selling for Co = 10. The discount factor for the period 0 to T is dor = 98/100 This problem shows that for these values, there is an arbitrage opportunity. Consider the portfolio constructed at t = 0 by selling (short) one unit of the asset, buying one call option, and depositing the present value of the strike in an ideal bank at the risk-free rate. In constructing the portfolio, the cash flow relative to your wallet at time 0 is (1) 48 >0 At t=0 the funds in the bank equal the present value of the strike: (2) 48 Att T the funds in the bank have grown to (3) 51.0204 Att =T, withdraw the funds from the bank and reacquire and return asset to owner. If ST > K, reacquire the asset by exercising the call option: the total cash flow at time T is (4) -K If ST 0. Since there is an immediate payoff of cash at t = 0 and no possibility of a negative cash flow at t =T, there is an arbitrage opportunity (type A) (1 point) An asset has value S = 60 at t = 0, and will have unknown value Sy at time T. A call option on the asset with strike K = 50 is currently (t = 0) selling for Co = 10. The discount factor for the period 0 to T is dor = 98/100 This problem shows that for these values, there is an arbitrage opportunity. Consider the portfolio constructed at t = 0 by selling (short) one unit of the asset, buying one call option, and depositing the present value of the strike in an ideal bank at the risk-free rate. In constructing the portfolio, the cash flow relative to your wallet at time 0 is (1) 48 >0 At t=0 the funds in the bank equal the present value of the strike: (2) 48 Att T the funds in the bank have grown to (3) 51.0204 Att =T, withdraw the funds from the bank and reacquire and return asset to owner. If ST > K, reacquire the asset by exercising the call option: the total cash flow at time T is (4) -K If ST 0. Since there is an immediate payoff of cash at t = 0 and no possibility of a negative cash flow at t =T, there is an arbitrage opportunity (type A)

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