Shalaunda Bennett

Use the put-call parity relationship to estimate the put premium that is consistent with the following other terms. Exercise price for both put and call = $25, Market price of stock = $24.15, Risk free interest rate = 2.4%, Call premium = $0.25. The option expires in one year.

When reading this question on the exam, I was baffled and asked myself where should I begin. I started by first identifying all the variables involved.

K = $25

rf = 0.024 (2.4%)

So = $24.15

Co = $0.25

Next I found the equation that best matched my situation

Po = Co - So + PV(K)

Next thought….what is PV(K)???

PV(K) = K___

(1 + rf )T

So…Using the formula for Po we have

Po = Co - So + PV(K)

= .25 – 24.15 + [25/(1+.024)]

= .514

page revision: 0, last edited: 05 Dec 2008 04:38