Consider a stock with a current price of P = $27. Suppose that over the next 6 months the stock price will either go up by a factor of 1.41 or down by a factor of 0.71. Consider a call option on the stock with a strike price of $25 which expires in 6 months. The risk-free rate is 6%.

1. Using the binomial model, what are the ending values of the stock price? What are the payoffs of the call option?

MINI CASE

Assume that you have just been hired as a financial analyst by Triple Play Inc., a mid-sized California company that specializes in creating high-fashion clothing. Since no one at Triple Play is familiar with the basics of financial options, you have been asked to prepare a brief report that the firm's executives could use to gain at least a cursory understanding of the topic. To begin, you gathered some outside materials the subject and used these materials to draft a list of pertinent questions that need to be answered. In fact, one possible approach to the paper is to use a question-and-answer format. Now that the questions have been drafted, you have to develop the answers.