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What are convexity violations for the call and put premiums?

Derivatives (4)

  1. Assume that oil forward prices for 1 year, 2 years, and 3 years are $18, $19, and $20. The 1-year effective annual interest rate is 6.5%, the 2-year interest rate is 7.0%, and the 3-year interest rate is 7.5%.

    a. What is the 3-year swap price?

    b. What is the price of a 2-year swap beginning in one year? (That is, the first swap settlement will be in 2 years and the second in 3 years.)

  2. You are the financial manager of a company and you are presented with this scenario: The exchange rate is 0.95 $/€, the euro-denominated continuously compounded interest rate is 4%, the dollar-denominated continuously compounded interest rate is 6%, and the price of a 1-year 0.93-strike European call on the euro is $0.0571. Calculate the price of a 0.93-strike European put.
  3. Given the call and put prices below

    Strike                  55           60             65

    Call premium      20           16        11.50

    Put premium        9       12.75        16.45

a. What are convexity violations for the call and put premiums?

b. What spread you would you use to effect arbitrage?

c. Demonstrate that the spread position is an arbitrage.

Complete your 2-4 page response using Microsoft Word or Excel. For calculations, you must show work to receive credit.

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