Interest rates are 5%. A European call with a strike price of $50 and a maturity of one year is worth $6. A European put with a strike price of $50 and a maturity of one year is worth $7. The current stock price is $49. Which of the following is true?

a.

The put price is high relative to the call price

 b.

The call price is high relative to the put price

c.

To take advantage of this one would buy the put, buy the stock using borrowed funds and sell the call to make an automatic profit  

 

c.) To take advantage of this one would buy the put, buy the stock using borrowed funds and sell the call to make an automatic profit  

Step-by-step explanation

Call and put price is not high relative to each other. Here we need to check if we have any arbitrage opportunity.

If call and put price follows call-put parity then we have no arbitrage opportunity else one can make automatic gain out of it.

As per call put parity...

Call premium + Present value of strike = Put premium + Spot price

$6 + $50 * e^(0.06*1) = $7 + $49

$53.09 = $56

So, the call put parity is not satisfied means we have arbitrage opportunity. To take advantage of this one would buy the put, buy the stock using borrowed funds and sell the call to make an automatic profit.