Stewart Enterprises’ current stock price is $60 per share. Call options for this stock exist that permit the holder to purchase one share at an exercise price of $50. These options will expire at the end of 1 year, at which time Stewart’s stock will be selling at one of two prices, $45 or $70. The risk-free rate is 7%. As an assistant to the firm’s treasurer, you have been asked to perform the following tasks to arrive at the value of the firm’s call options.
a. Find the range of values for the ending stock price and the call option at the option’s expiration in 1 year.
b. Equalize the range of payoffs for the stock and the option.
c. Create a riskless hedged investment.
d. What is the cost of the stock in the riskless portfolio?
e. What is the present value of the riskless portfolio?
f. From your answers in Parts d and e, what is the value of the firm’s call option?