Note: a variant of these questions was in a previous final exam paper.
Students are referred to the unit outline which provides details on the assessments, including the
due date and time which will be strictly enforced. Students are reminded that their assignment
should be their own work. Both questions must be answered. Answers are mathematical and hence
a marking rubric is not required.
Questions
Let C K( ) denote a European vanilla Call option with strike price K. Assume that all options are
identical except for strike price, and strike prices satisfy KKK 123 < < and 2 13 2K KK = + . Assume
also that interest rates are zero.
Question 1 [5 marks]
What are the no-arbitrage lower bound, and the no-arbitrage upper bound, of the vertical spread
CK CK ( 1 2 )− ( ) ?
Question 2 [10 marks]
What is the functional relationship between the no-arbitrage values of the two vertical spreads,
CK CK ( 1 2 )− ( ) and CK CK ( 2 3 )− ( ) ?
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