Assume that a stock is currently selling for $33, and that its price is equally likely to increase by 10% or decrease by 5% in the next instant. Assume that bonds increase at the risk-free rate of 1
+ 0.2% each instant. Determine the current value of a call option on this stock that will expire
In one instant and has a strike price of $35. Round your answer to the nearest cent.

Question

Quizplus · Accepted Answer

To find the value of the call option, we use the following formula:
Value of call option = probability of stock increasing * (value of stock if it increases - strike price) + probability of stock decreasing * 0
First, we need to find the possible prices of the stock after one instant:
If the stock increases by 10%, its new price will be $36.30
If the stock decreases by 5%, its new price will be $31.35
Next, we need to calculate the probabilities of each scenario:
Probability of stock increasing = 0.5 (since it is equally likely to increase or decrease)
Probability of stock decreasing = 0.5
Now we can plug in the values into the formula:
Value of call option = 0.5 * ($36.30 - $35) + 0.5 * $0
Value of call option = $0.45 (rounded to nearest cent)
Therefore, the best choice is A.

Assume That a Stock Is Currently Selling for $33, and That