Currently, T-bills yield 3.8 percent and MTM stock sells for $38 a share. There is no possibility that the stock will be worth less than $36 per share in one year. What is the value of a call option on this stock if the exercise price is $35 per share?

Question

Quizplus · Accepted Answer

The call option value is calculated as the difference between the stock price and the exercise price, discounted by the risk-free rate. The stock price is $38, the exercise price is $35, and the risk-free rate is 3.8%. The intrinsic value is $38 - $35 = $3. Discounting this by the risk-free rate gives $3 / (1 + 0.038) ≈ $2.89. However, considering the minimum stock price of $36, the option value is $36 - $35 = $1, which when added to the discounted intrinsic value gives approximately $4.28.

Currently, T-Bills Yield 3