SØK460/ECON460 Finance Theory, Fall semester, 2002
Exercise no. 5
Exam Spring 1993, question 2
Discuss if the following observations can be consistent with a competitive market equilibrium. Assume that the interest rate of risk free six-month bonds is 5 percent per six
months. If it is possible to earn arbitrage profits, show how.
(a) A share is traded at 108 kroner. It is known for sure that the share will not pay
dividends for the next six months. A European call option on the share is traded at
the same time at 5 kroner. The option’s maturity is in six months, and its exercise
price is 105 kroner.
(b) A share (not the same as the one mentioned in part (a)) is traded at 108 kroner.
An American call option on the share is traded at the same time at 5 kroner. The
option’s maturity is in six months, and its exercise price is 105 kroner.