Finance Derivates

Finance (Derivative Securities)

Trimester 3A 2013 ASSIGNMENT 2 Note: a variant of these questions was in a previous final exam paper. Students are referred to the unit outline which provides details on the assessments, including the due date and time which will be strictly enforced. Students are reminded that their assignment should be their own work. Both questions must be answered. Answers are mathematical and hence a marking rubric is not required. Questions Let ( )C K denote a European vanilla Call option with strike price K . Assume that all options are identical except for strike price, and strike prices satisfy 1 2 3K K K< < and 2 1 32K K K= + . Assume also that interest rates are zero. Question 1 [5 marks] What are the no-arbitrage lower bound, and the no-arbitrage upper bound, of the vertical spread ( ) ( )1 2C K C K− ?

Question 2 [10 marks] What is the functional relationship between the no-arbitrage values of the two vertical spreads, ( ) ( )1 2C K C K− and ( ) ( )2 3C K C K− ?