Consider the following two strategies on a non-dividend paying stock. Both strat
ID: 2612522 • Letter: C
Question
Consider the following two strategies on a non-dividend paying stock. Both strategies are implemented at t = 0, when the current stock price is S and the risk-free rate is r.
Strategy 1: Long a forward contract on the stock with a delivery price K that expires at T
Strategy 2: Buy a European call option with a strike K and maturity T.
A. What are the payoffs of both strategies at time T? Does one strategy dominate the other?
B. Find a lower bound for the price of the European call options using your result from part (a).
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Explanation / Answer
A. Payff of Strategy 1 K Payff of Strategy 2 K No one strategy does not dominate the other B. Lower bound fr price of the Eurpean call K-S