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Has anyone looked at 2020 Fall Exam Q#7c. Trying to understand why the replicating trades would be a long ATM call and short call(K=105). What happens if the index ends up below 100? Neither of those options would be exercised but the company would still have to pay the initial amount right? Based on my understanding, no negative returns are being paid to customer so I thought we would be hedging the downside as well.
I was thinking to long the index, long an ATM put and short a call (K=105).
Any thoughts?
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