Suppose ABCD's stock price is currently $50.In the next six months it will either fall to $40 or rise to $60.What is the current value of a six-month call option with an exercise price of $50? The six-month risk-free interest rate is 2 percent (periodic rate).

Question

Quizplus · Accepted Answer

The call option value is calculated using the risk-neutral valuation method. The expected payoff is calculated as the weighted average of the payoffs in the up and down states, discounted at the risk-free rate. The expected payoff is $10 (if the stock goes up) and $0 (if it goes down). The risk-neutral probability of the stock going up is 0.5. The present value of the expected payoff is $5.39.

Suppose ABCD's Stock Price Is Currently $50