This should be done in 10 minutes and done well with accuracy.

Part I

1. Consider the following “portfolio:” buy a call at the premium Vc and buy a Treasury bill having price-per-face of β and face of E, where E is the exercise price of the option. Now show how you would “short” this portfolio. What is the payoff pattern? Explain.

2. Why does the U.S. Treasury now prefer to use “uniform price” auctions to sell its securities rather than “discriminatory price” auctions? Explain.

3. Draw a profit profile (diagram showing the profit level for all possible prices of the underlying security of an option) for the case of written (sold) put.

a. Explain the shape of your diagram.

b. Now suppose the price of the underlying security rises. What will the profit profile look like now to someone who now writes this put? Draw the new profit profile and explain how it is different from the previous one.