Suppose you want to value a call option (expiring in one year, with strike price 102) on
Question:
Suppose you want to value a call option (expiring in one year, with strike price £102) on a certain stock, when the current share price is £100. The expected price of one share in one year in £108, and the risk-free rate is 5%.
a. Assume that there is a 50% percent of chance that the price will rise to £128 and a 50% chance of the price will fall to y. What is y?
b. Find a portfolio of bonds and shares that replicates the payoffs of the option. What is the cost of this portfolio?
c. What is the risk-neutral probability of a rise in the share price?
d. What is the value of the option?
e. What happens to the value of option if the share price in the good state is £148, and £68 in the bad state? Can you explain why the value of the option changes?
Fundamentals Of Corporate Finance
ISBN: 9780135811603
5th Edition
Authors: Jonathan Berk, Peter DeMarzo, Jarrad Harford