I am software developer with no previous experience or knowledge in finance and have recently been starting to build my knowledge in this area. I am working through the book: Paul Wilmott Introduces Quantitative Finance. I ran into an exercise question that I haven't been able to fully figure and was hoping someone could enlighten me.
A share currently trades at $60. A European call with exercise price $58 and expiry in three months trades at $3. The three month default-free discount rate is 5%. A put is offered on the market, with exercise price $58 and expiry in three months, for $1.50. Do any arbitrage opportunities now exist? If there is a possible arbitrage, then construct a portfolio that will take advantage of it. (This is an application of put-call parity.)
I have been able to figure out that there is in fact arbitrage (I think anyway) in this situation using the formula C - P = S - Ee^-r(T - t) which gives a value of 1.5 on the left side and 2.8 on the right. The part I can't figure out is how to construct a portfolio to take advantage of the arbitrage.
Also, if anyone can clarify what it means when C - P is less than the right side of that equation vs. when it is greater than the right side would be very helpful as well.