A house in Melbourne has recently sold for $2.5 million. Renting an equivalent house costs $250,000...

 

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A house in Melbourne has recently sold for $2.5 million. Renting an equivalent house costs $250,000 per year (paid at year-end). The risk-free rate is 7.5% (annually compounded). Suppose the house can either increase in price each year by 20% or decrease by 20% before rent is paid out (i.e. cum-dividend). For example, the price can increase from $2.5 million to $3.0 million, so that after $250,000 rent is paid out (i.e. ex-dividend), the house is worth $2.75 million. i. ii. What is the price of a 2-year at-the money American call option on the house? State any assumptions you need to make. Holding all else constant, how would each of the following affect your answer to part (i): ● ● an increase in the rent a decrease in the price of the house a decrease in the strike price of the option In each case, state the direction of the change (i.e., increase the price, decrease the price, or uncertain) and provide a brief explanation of your reasoning. A house in Melbourne has recently sold for $2.5 million. Renting an equivalent house costs $250,000 per year (paid at year-end). The risk-free rate is 7.5% (annually compounded). Suppose the house can either increase in price each year by 20% or decrease by 20% before rent is paid out (i.e. cum-dividend). For example, the price can increase from $2.5 million to $3.0 million, so that after $250,000 rent is paid out (i.e. ex-dividend), the house is worth $2.75 million. i. ii. What is the price of a 2-year at-the money American call option on the house? State any assumptions you need to make. Holding all else constant, how would each of the following affect your answer to part (i): ● ● an increase in the rent a decrease in the price of the house a decrease in the strike price of the option In each case, state the direction of the change (i.e., increase the price, decrease the price, or uncertain) and provide a brief explanation of your reasoning.

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i Price of the 2year atthe money American call option Assumptions The option is American meaning the holder can exercise it at any time before expiry ... View the full answer