Final answer:
Execute a trade to buy the put and the stock, and to sell the call and the risk-free bonds, to exploit the arbitrage opportunity presented when the market price of a European call is higher than predicted by the put-call parity.
Step-by-step explanation:
If you find the market price of a European call to be higher than the price given by the put-call parity, you should execute a trade to exploit this arbitrage opportunity. The appropriate action would be to buy the put and the stock, and sell the call and the risk-free bonds. This trade takes advantage of the price discrepancy by locking in a risk-free profit once the prices converge to the put-call parity relationship.
This arbitrage strategy works because, according to the put-call parity formula, the relationship between the prices of European puts and calls on the same stock with the same strike price and expiration should be fixed based on the current stock price and the present value of the strike price discounted at the risk-free interest rate. If the prices diverge from this relationship, an arbitrageur can profit from the difference. However, it is essential to remember that in practice, one must consider various factors such as potential capital gains, dividends, and the prevailing interest rate environment. These factors influence investors' decisions on whether to buy or sell securities, accounting for their differing expectations on a stock's future prospects.