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You work on a proprietary trading desk of a large investment bank, and you have been asked

Question:

You work on a proprietary trading desk of a large investment bank, and you have been asked for a quote on the sale of a call option with a strike price of $50 and one year of expiration. The call option would be written on a stock that does not pay a dividend.

From your analysis, you expect that the stock will either increase to $70 or decrease to $35 over the next year. The current price of the underlying stock is $50, and the risk-free interest rate is 4% per annum.

a. Briefly describe the steps involved in applying binomial option pricing model to value the call option in this situation.

b. What is this fair market value for the call option under these conditions?


Strike Price
In finance, the strike price of an option is the fixed price at which the owner of the option can buy, or sell, the underlying security or commodity.
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Step by Step Answer:

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a and b OR Step 1 Set up binomial tree and calculate the option values at expiration for each ending ...View the full answer


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Srilekha Talluri
I am a final year Computer science student at Bits Hyderabad. I have recently completed my internship at Amazon. I worked as a SDE Intern with Seller central team of Amazon. I have also done an internship with Human Resource department of Telangana Govt Secretariat. Due to these exposure i had the opportunity of putting my subject into action and make an impact. I have also done good projects in my Discipline and worked as teaching assistant for few important Computer science courses like Data Structures and Algorithms, Discrete Mathematics. As a computer science student, I have completed lot of courses like Cryptography, Graph theory, Design and Analysis of Algorithms etc. My teaching experience has been awesome throughout .I have had many occasions to experience teaching. I have been fortunate enough to teach underprivileged children as a part of a NGO on college. I taught them the essential aspects of writing, mathematics,science etc. They were able to excel in the board exams they undertook that year and got themselves admitted to XII class. The experience was wonderful and it caught me by surprise that many of the students never realize their true potential and just need a little external help to overcome huge barriers in academics. Working as a teaching Assistant for disciplinary courses also helped me to gain good knowledge and tutoring experience
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Investment Analysis and Portfolio Management

Investment Analysis and Portfolio Management

ISBN: 978-0538482387

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Authors: Frank K. Reilly, Keith C. Brown

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Related Video

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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