Suppose that a share of Microsoft stock is currently priced at $50 per share and that in one time period it will be either $40 per share or $60 per share. Also, suppose that a share of Pepsi stock is currently priced at $40 per share and that in one time period it will go down to $35 per share or go up to $45 per share where one time period is one day.

(a) Using a state price vector, find a fair price of a European call option on Microsoft stock with expiration at time t = 1 day and strike price X = $50.

(b) Using a state price vector, find a fair price of a European put option on Pepsi stock with expiration at time t = 1 day and strike price X = $34.

Answer rating: 100% (QA)

a For the Microsoft call option There are two states at ... View the full answer