What is the difference between “Profit” and “Intrinsic Value” in an option contract? Explain.

1.       What is the difference between “Profit” and “Intrinsic Value” in an option contract? Explain.

2.       How do the forward contracts and futures contracts are different from each other? Explain.

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3.       As a strategy, which one would you prefer: speculation or arbitrage? Clarify your answer.

4.       If a stock of Microsoft is trading at $70 at expiry, the strike price is $85, and if you have bought a call option on that stock, and the call options cost the buyer $5, what is your profit at expiration?

5.       Suppose an investor purchases a call option with a strike price of $40 for a $8 premium when the underlying stock was trading at $46 per share.  What is his profit at expiration?

6.       Suppose a share of stock sells for $66.55. A two year at the money call option sells for $30. An at the money put option with the same maturity sells for $18.45 . Can you create a risk-free investment by combining these three investments? How? What’s the risk-free rate?

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