Reference no: EM132665978

Consider a European call option and a European put option that have the same underlying stock, the same strike price K, and the same expiration date T. Let C denote the Call premium, P denote the Put premium, and S denote the current stock price. Suppose the risk-free borrowing rate rb is higher than the risk-free lending rate rl , i.e., rb > rl .

a. Use the put option, the stock, and either risk-free borrowing or lending to replicate the payoff of longing the call option.

b. Use the put option, the stock, and either risk-free borrowing or lending to replicate the payoff of shorting the call option.

c. Express the arbitrage restriction for the Call premium C with P, S, K, T, rb, and rl , i.e., find the upper bound and the lower bound for C such that no arbitrage opportunity exists.