Payoff with Long position

CFA Level II Derivatives
#1

Identify the trading strategy that will generate the payoffs of taking a long position in a call option within a single-period binomial framework.

  1. Buy h = (c+ + c–)/(S+ + S–) units of the underlying and financing of –PV(–hS– + c–)
  2. Buy h = (c+ – c–)/(S+ – S–) units of the underlying and financing of –PV(–hS– + c–)
  3. Short sell h = (c+ – c–)/(S+ – S–) units of the underlying and financing of +PV(–hS– + c– )

The answer says at time 0 Buy -C and Buy -hS… should he be writing hS ( to hedge against the buy)?

Pg 382

#2

Ques is asking us to replicate the pay off of a long call position. We would need to buy a share to replicate long call position and finance it with borrowing. If ques would have ask us to calculate arbitrage profit, what you r saying would have been right. Hope this helps.

#3

I came across this example as well (Example 1 page 382 Long Call Option Replicated with Underlying and Financing) and I am still trying to get my head around this concept.

It appears answer A and B are identical.

I believe what is being asked in my own words “What response below is the equivalent to buying a call option?”

  1. Buy h = (c+ + c–)/(S+ + S–) units of the underlying and financing of –PV(–hS– + c–)
  2. Buy h = (c+ – c–)/(S+ – S–) units of the underlying and financing of –PV(–hS– + c–)
  3. Short sell h = (c+ – c–)/(S+ – S–) units of the underlying and financing of +PV(–hS– + c– )

More or less just trying to talk this one through and see if I can better understand.

#4

What is the difference between response A and B in the above question?

#5

what about the negative sign behind PV? if this is a financing, isn’t that a cash inflow, hence it should be +PV ?