In July 2010 a call option on Google stock with a January 2011 expiration and exercise price of $460 sold for $42.50. Suppose that by the end of January 2011 the price of Google stock could double to $920 or halve to $230. The rate of interest on a bank loan at this time

a. What would be the value of the Google call in January 2011 if the stock price is $920? If it is $230?

b. Show that a strategy of buying three calls provides exactly the same payoffs as borrowing the present value of $460 from the bank and buying two shares.

c. What is the net cash flow in July 2010 from the policy of borrowing PV($460) and buying two shares?

d. What does this tell you about the value of the call option?

Exercise price .......................... $460.00

Call option price..........................$42.50

Price of Google stock-1................$920.00

Price of Google stock-2................$230.00

Bank loan.................................$460.00

No. of shares can be bought................2.00

No. of calls can be bought...................3.00

Interest rate for 6 months.................1.50%