Finance (Derivative Securities) Version 2 Dr. Kurt Smit

Finance (Derivative Securities) Version 2 Dr. Kurt Smith Page 1 ASSIGNMENT 1 [10 marks] Instructions This assignment must be your own work. Answer all questions. This assignment is worth a total of ten [10] marks. The deadline for submission is Friday 29th November 2013 at 12:00. Submit your assignment in accordance with the submission details on Blackboard. Question 1 [5 marks] Two securities J and K are trading in the market. Their end-of-period payoffs for state 1 and state 2 and their current traded market prices are shown in the table below: Security Payoff (S1 S2) Traded Price J (23) $0.08 K (31) $0.05 What is the no-arbitrage value of security L with end-of-period payoffs (14)? [5 marks] Question 2 [2 marks] Three securities T U and V are trading in the market. Their end-of-period payoffs for state 1 and state 2 and their current traded market prices are shown in the table below: Security Payoff (S1 S2) Traded Price T (10) $0.60 U (01) $0.70 V (43) $4.30 Construct a trade consisting of T U and V to extract an arbitrage profit. Make sure that you clearly specify which securities are bought or sold as well as the size of the arbitrage profit. Question 3 [3 marks] The risk-free interest rate for the period is 10%. An underlier currently trades at $100 and it is expected to trade at either $90 or $120 at the end of the period. (i) What is the no-arbitrage value of a forward contract on the underlier if the forward asset price in the contract is $110? [2 marks]; and (ii) Explain why the value in (i) is that value [1 mark].
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