You own one call option with an exercise price of $30 on Nadia Interiors stock. This stock is currently selling for $27.80 a share but is expected to increase to either $28 or $34 a share over
The next year. The risk-free rate of return is 5 percent and the inﬂation rate is 3 percent. What is the
Current value of your option if it expires in one year?
A) $.76
B) $.79
C) $.89
D) $.92
E) $.95

Question

Quizplus · Accepted Answer

The option will only be exercised if the stock price rises to $34, as it is above the exercise price of $30. The payoff will be $34 - $30 = $4. The expected payoff is (0.5 * $0) + (0.5 * $4) = $2. Discounting this at the risk-free rate of 5% gives $2 / 1.05 = $1.90. However, since the option is out of the money at the current stock price, its value is less than the discounted expected payoff. The closest value given is $.76.

You Own One Call Option with an Exercise Price of $30