The risk-free rate is 5% and the expected return on a non-dividend-paying stock is 12%.Which of the following is a way of valuing a derivative?
A) Assume that the expected growth rate for the stock price is 17% and discount the expected payoff at 12%
B) Assuming that the expected growth rate for the stock price is 5% and discounting the expected payoff at 12%
C) Assuming that the expected growth rate for the stock price is 5% and discounting the expected payoff at 5%
D) Assuming that the expected growth rate for the stock price is 12% and discounting the expected payoff at 5%

Question

Quizplus · Accepted Answer

Risk-neutral valuation shows that a derivative can be correctly valued by assuming that the stock grows at the risk-free rate and discounting the expected payoff at the risk-free rate.It follows that C is the correct answer.

The Risk-Free Rate Is 5% and the Expected Return on a Non-Dividend-Paying