You would buy the American call for $75, exercise the call immediately in order to purchase a share of Pintail stock for $50, and then sell the share of Pintail stock for $200. The net gain is: $200 – ($75 + $50) = $75. If the call is a European call, you should buy the call, deposit in the bank an amount equal to the present value of the exercise price, and sell the stock short. This produces a current cash flow equal to: $200 – $75 – ($50/1 + r) At the maturity of the call, the action depends on whether the stock price is greater than or less than the exercise price. If the stock price is greater than $50, then you would exercise the call (using the cash from the bank deposit) and buy back the stock. If the stock price is less than $50, then you would let the call expire and buy back the stock. The cash flow at maturity is the greater of zero (if the stock price is greater than $50) or [$50 – stock price] (if the stock price is less than $50). Therefore, the cash flows are positive now and zero or positive one year from now.
E19, Page 549:
Statement (b) is correct. The appropriate diagrams are in Figure 20.6 in the text. The first row of diagrams in Figure 20.6 shows the payoffs for the strategy:
Buy a share of stock and buy a put.
The second row of Figure 20.6 shows the payoffs for the strategy:
Buy a call and lend an amount equal to the exercise price.
E27, Page 550:
Consider each company in turn, making use of the put-call parity relationship:
Value of call + Present value of exercise price = Value of put + Share price
Here, the left-hand side [$52 + ($50/1.05) = $99.62] is less than the right-hand side [$20 + $80 = $100]. Therefore, there is a slight mispricing. To take advantage of this situation, one should buy the call, invest $47.62 at the risk-free rate, sell the put, and sell the stock short.
Here, the left-hand side...