Chapter 10 - Characteristics Of Derivative Securities Flashcards
What does Put-Call Parity state?
c_t + Kexp(-r(T-t)) = p_t + S_t
This equation relates the prices of European call and put options with the same strike price and expiration date.
What happens if Put-Call Parity is not true?
It would lead to arbitrage opportunities.
Arbitrage opportunities arise when discrepancies exist in pricing, allowing traders to profit without risk.
Fill in the blank: If Put-Call Parity is violated, it leads to _______.
arbitrage opportunities.
What do the variables c_t, p_t, S_t, K, r, T, and t represent in the Put-Call Parity equation?
- c_t: price of the call option
- p_t: price of the put option
- S_t: price of the underlying asset
- K: strike price
- r: risk-free interest rate
- T: expiration date
- t: current time
What is the Upper Bound for a Call Option?
Max(S_t - K*exp(-r(T-t)),0)
What is a derivative?
A security or contract that promises to make a payment at a specified time in the future, depending on the behaviour of some underlying security.
What is an arbitrage opportunity?
A situation where we can make a certain profit with no risk.
What does the principle of no arbitrage state?
Arbitrage opportunities do not exist.
What does the law of one price state?
Any two portfolios that behave in exactly the same way must have the same price.
What is the intrinsic value of a derivative?
The value assuming expiry of the contract immediately rather than at some time in the future.
Fill in the blank: The intrinsic value of a derivative is the value assuming _______.
[expiry of the contract immediately]
True or False: Arbitrage opportunities exist according to the principle of no arbitrage.
False
What is the formula to calculate time value?
Time Value = Value of Option - Intrinsic Value
What is the formula to calculate intrinsic value?
Call:
IV = max{ S_t - K,0}
Put:
IV =max{ K - S_t, 0}
