Chartered Financial Analyst (CFA) Practice Exam Level 2

Which equation represents the Put-Call Parity relationship?

1. S + P = C + PV(X)

2. S + P = PV(X) + C

3. S = PV(X) + C - P

4. S + PV(X) = P + C

The correct answer is: S + P = PV(X) + C

The Put-Call Parity relationship is a fundamental principle in options pricing that establishes a connection between the prices of European put and call options with the same strike price and expiration date. The relationship can be mathematically represented, where: - S is the current price of the underlying asset, - C is the price of a European call option, - P is the price of a European put option, - PV(X) is the present value of the exercise price (strike price, X). The correct representation of the Put-Call Parity is that the current price of the underlying asset plus the present value of the exercise price is equal to the sum of the price of the call option and the price of the put option. This can be expressed as: S + PV(X) = C + P. This equation outlines the equality that must hold in a well-functioning market, ensuring that arbitrage opportunities do not exist. If the parity does not hold, it implies that traders could create a risk-free profit by exploiting the price differences. In this context, the correct statement captures the relationship accurately, highlighting how the combination of the current asset price and the exercise price's present value balances with the values of the call and put options. Understanding this relationship is