3) No arbitrage principle

Question 1

What is a trading strategy and how is its value represented

Answer 1

A trading strategy is a predictable process (∆t, Nt)
Δt is the amount held in the risky asset and Nt in the risk-free asset
The current value of the portfolio is: Πt = Δt St +Nt Bt

Question 2

What is a self-financing trading strategy

Answer 2

A self-financing strategy is a trading strategy where no external money is added or withdrawn during trading. At each trading time t=kϵ, the portfolio’s value before and after the trade remains the same: (Δt+)St + (Nt+)Bt =(Δt−)St+(Nt−)Bt

Here, t− is just before the trade, and t+ is just after

Question 3

What is a Portfolio

Answer 3

A collection of one or more financial contracts is known as a portfolio

Question 4

What is an arbitrage opportunity

Answer 4

Question 5

How can you identify an arbitrage opportunity using a forward contract

Answer 5

Question 6

What is the correct (no-arbitrage) delivery price for a forward contract

Answer 6

Question 7

What is the Put-Call Parity

Answer 7

Question 8

How can you derive the put-call parity relationship using a no-arbitrage portfolio

Answer 8