Question #59 - Reading 31 Valuation of Contingent Claims

Reading: Reading 31 Valuation of Contingent Claims

PDF File: Reading 31 Valuation of Contingent Claims.pdf

Page: 27

Status: Unattempted

Shared Context

- Using the information in Exhibits 1 and 2, which of the following is closest to the amount of the British pound paid on the first settlement date? A) £165,000. B) £187,234. C) £264,000.

Question

Which of the following would create a synthetic call?

Answer Choices:

A. Buy the put and the underlying

B. Sell the put, buy the underlying

C. Sell the put and the underlying

Explanation

When dealing with questions based on synthetics the solution can be arrived at by using put call parity. Recall put + share = call + present value of bond PV(X) The European put-call parity states that the payoffs of a fiduciary call (long zero coupon bond and long call) are equivalent to the payoffs of a protective put (long underlying and long put). So a synthetic call = put + stock – PV(X) We can then ignore the value of the pure discount bond PV(X) because its value is unaffected by the stock's price, leaving us with put + stock.

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