Question: Consider a stock worth $25 that can go up or down by 15 percent per period. The risk-free rate is 10 percent. Use one binomial

Consider a stock worth $25 that can go up or down by 15 percent per period. The risk-free rate is 10 percent. Use one binomial period.
a. Determine the two possible stock prices for the next period.
b. Determine the intrinsic values at expiration of a European call option with an exercise price of $25.
c. Find the value of the option today.
d. Construct a hedge by combining a position in stock with a position in the call. Show that the return on the hedge is the risk-free rate regardless of the outcome, assuming that the call sells for the value you obtained in part c.
e. Determine the rate of return from a riskless hedge if the call is selling for $3.50 when the hedge is initiated.

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a 25115 2875 25085 2125 b Max0 2875 25 375 Max0 2125 25 0 c p 110 085115 085 08333 ... View full answer

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