# Question: Assuming that a one year call option with an exercise price

Assuming that a one-year call option with an exercise price of $38 is available for the stock of the DEW Corp., consider the following price tree for DEW stock over the next year:

a. If the sequence of stock prices that DEW stock follows over the year is $40.00, $42.00, $40.32, and $38.71, describe the composition of the initial riskless portfolio of stock and options you would form and all the subsequent adjustments you would have to make to keep this portfolio riskless. Assume the one-year risk-free rate is 6 percent.

b. Given the initial DEW price of $40, what are the probabilities of observing each of the four terminal stock prices in one year? (Hint: In arriving at your answer, it will be useful to consider (1) the number of different ways that a particular terminal price could be achieved and (2) the probability of an up or down movement.)

c. Use the binomial option model to calculate the present value of this call option.

d. Calculate the value of a one-year put option on DEW stock having an exercise price of $38; be sure your answer is consistent with the correct response to Partc.

a. If the sequence of stock prices that DEW stock follows over the year is $40.00, $42.00, $40.32, and $38.71, describe the composition of the initial riskless portfolio of stock and options you would form and all the subsequent adjustments you would have to make to keep this portfolio riskless. Assume the one-year risk-free rate is 6 percent.

b. Given the initial DEW price of $40, what are the probabilities of observing each of the four terminal stock prices in one year? (Hint: In arriving at your answer, it will be useful to consider (1) the number of different ways that a particular terminal price could be achieved and (2) the probability of an up or down movement.)

c. Use the binomial option model to calculate the present value of this call option.

d. Calculate the value of a one-year put option on DEW stock having an exercise price of $38; be sure your answer is consistent with the correct response to Partc.

## Answer to relevant Questions

Following is a two-period price tree for a share of stock in SAB Corp.:Using the binomial model, calculate the current fair value of a regular call option on SAB stock with the following characteristics: X = 28, RFR = 5 ...In March, a derivatives dealer offers you the following quotes for June British pound option contracts (expressed in U.S. dollars per GBP):a. Assuming each of these contracts specifies the delivery of GBP 31,250 and expires ...Total return swaps and credit default swaps were both developed as tools to help investors manage credit risk. In practice, however, credit default swaps are used far more widely. Compare the relevant features of both ...To protect the value of the Star Hospital Pension Plan's bond portfolio against the rising interest rates that she expects, Sandra Kapple enters into a one-year pay fixed, receive floating U.S. LIBOR interest rate swap, as ...You are an investor trying to value a gold mining company's lease on a gold mine that is currently not operating. It would cost $1,000,000 for the company to reopen the mine, and it is expected to produce 100,000 ounces of ...Post your question