Review of Put-Call Parity and Binomial Option Pricing

The Actuary's Free Study Guide for Exam 3F / Exam MFE - Section 32

This section of sample problems and solutions is a part of The Actuary's Free Study Guide for Exam 3F / Exam MFE, authored by Mr. Stolyarov.

This is Section 32 of the Study Guide. See Section 1 here. See Section 2 here. See Section 3 here. See Section 4 here. See Section 5 here. See Section 6 here. See Section 7 here. See Section 8 here. See Section 9 here. See Section 10

here. See Section 11 here. See Section 12 here. See Section 13 here. See Section 14 here. See Section 15 here. See Section 16 here. See Section 17 here. See Section 18 here. See Section 19 here. See Section 20 here. See Section 21 here. See Section 22 here. See Section 23 here. See Section 24 here. See Section 25 here. See Section 26 here. See Section 27 here. See Section 28 here. See Section 29 here. See Section 30 here. See Section 31 here.

This section will review all the concepts we have worked with thus far. It applies the ideas of put-call parity and binomial option pricing discussed in Sections 1 through 31.

The problems in this section were designed to be similar to problems from past versions of Exam 3F / Exam MFE. They use original exam questions as their inspiration - and the specific inspiration for each problem is cited so as to give students a chance to see the original. All of the original problems are publicly available, and students are encouraged to refer to them. But all of the values, names, conditions, and calculations in the problems here are the original work of Mr. Stolyarov.

Problem RPCPBOP1.

Similar to Question 1 from the Society of Actuaries' May 2007 Exam MFE:

On October 1, 3451, the stock of Respectable Co. has a price of $300/share. Two equal dividends will be paid on May 1, 3452 and July 1, 3452. A European put option on Respectable Co. stock with strike price of $290 expiring in one year sells for $30, while a European call option on Respectable Co. stock with strike price of $290 expiring in one year sells for $53. The annual continuously-compounded risk-free interest rate is 12%. Find the amount of each dividend.

Solution RPCPBOP1. We use the formula for put-call parity on stock option: