Solution Manual for Derivatives Markets
Chapter 2
An Introduction to Forwards and Options
Question 2.1
The payoff diagram of the stock is just a graph of the stock price as a function of the stock price:
In order to obtain the profit diagram at expiration, we have to finance the initial investment. We
do so by selling a bond for $50. After one year, we have to pay back: $50 × (1 + 0.1) = $55. The
second figure (on the next page) shows the graph of the stock, of the bond to be repaid, and of the
sum of the two positions, which is the profit graph. The arrows show that at a stock price of $55,
the profit at expiration is indeed zero.
, 9
8
©2013 Pearson Education, Inc. Publishing as Prentice Hall
Chapter 2/An Introduction to Forwards and Options
Question 2.2
Since we sold the stock initially, our payoff at expiration from being short the stock is negative.
In order to obtain the profit diagram at expiration, we have to lend out the money we received from
the short sale of the stock. We do so by buying a bond for $50. After one year, we receive from
the investment in the bond: $50 × (1 + 0.1) = $55. The second figure shows the graph of the sold
©2013 Pearson Education, Inc. Publishing as Prentice Hall
Chapter 2
An Introduction to Forwards and Options
Question 2.1
The payoff diagram of the stock is just a graph of the stock price as a function of the stock price:
In order to obtain the profit diagram at expiration, we have to finance the initial investment. We
do so by selling a bond for $50. After one year, we have to pay back: $50 × (1 + 0.1) = $55. The
second figure (on the next page) shows the graph of the stock, of the bond to be repaid, and of the
sum of the two positions, which is the profit graph. The arrows show that at a stock price of $55,
the profit at expiration is indeed zero.
, 9
8
©2013 Pearson Education, Inc. Publishing as Prentice Hall
Chapter 2/An Introduction to Forwards and Options
Question 2.2
Since we sold the stock initially, our payoff at expiration from being short the stock is negative.
In order to obtain the profit diagram at expiration, we have to lend out the money we received from
the short sale of the stock. We do so by buying a bond for $50. After one year, we receive from
the investment in the bond: $50 × (1 + 0.1) = $55. The second figure shows the graph of the sold
©2013 Pearson Education, Inc. Publishing as Prentice Hall
