In a most simplified world, we suppose there are two states of the economy in one year The returns on stock ABC and on the market are as given below Stock ABC is currently traded at $40 Assume the CAPM holds Probability Stock ABC Market Boom 0 5 0 35 0 2 Recession 0 5 0 15 0 05 i) Calculate the expected returns on ABC and on the market ii) What is the beta of stock ABC iii) What is the risk free rate, assuming CAPM holds iv) Suppose that you want to write a one year call option on stock ABC with exercise price equal to $48 How much is the call option worth

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Question: In a most simplified world, we suppose there are two states of the economy in one year. The returns on stock ABC and on the

In a most simplified world, we suppose there are two states of the economy in one year. The returns on stock ABC and on the market are as given below. Stock ABC is currently traded at $40. Assume the CAPM holds.

	Probability	Stock ABC	Market
Boom	0.5	0.35	0.2
Recession	0.5	-0.15	-0.05

i) Calculate the expected returns on ABC and on the market. ii) What is the beta of stock ABC? iii) What is the risk-free rate, assuming CAPM holds? iv) Suppose that you want to write a one-year call option on stock ABC with exercise price equal to $48. How much is the call option worth?

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