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The current price of a stock is $55. In 1 year, the price will be either $50

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The current price of a stock is $55. In 1 year, the price will be either $50 or $65. The annual risk-free rate is 5.5%. The stock has an exercise price of $60 and expires in 1 year.

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 risk less hedged investment. What is the value of the portfolio in 1 year?

d. What is the cost of the stock in the risk less portfolio?

e. What is the present value of the risk less portfolio?

f. From your answers in parts d and e, what is the value of the firm’s call option? 

Portfolio
A portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non-publicly...
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a b Equalize ranges 515 03333 buy 03333 shares and sell 1 option c d e ...View the full answer


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Fundamentals of Financial Management

Fundamentals of Financial Management

ISBN: 978-1337395250

15th edition

Authors: Eugene F. Brigham, Joel F. Houston

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A call option is a type of financial contract that gives the holder the right, but not the obligation, to buy an underlying asset (such as a stock, commodity, or currency) at a specified price (called the strike price) within a specified period of time. When an investor purchases a call option, they are essentially betting that the price of the underlying asset will rise above the strike price before the option\'s expiration date. If the price of the asset does rise above the strike price, the investor can exercise the option by buying the asset at the strike price and then selling it at the higher market price, thereby earning a profit. Call options are often used as a speculative investment strategy, as they allow investors to potentially profit from the upward movement of an asset without having to actually own the asset itself. They are also commonly used as a hedging tool to protect against potential losses in a portfolio.

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