Assume a one-period world with current share price of $5.00,interest rate of 8% over the period and a price increase factor of 1.25.Given this information,the current premium on a call option with an exercise price of $4.50 using the binomial model is:

A) $ 1.0565 $
B) $ 1.1131 $
C) $ 1.1256 $
D) $ 1,3042$

Question

Assume a one-period world with current share price of $5.00,interest rate of 8% over the period and a price increase factor of 1.25.Given this information,the current premium on a call option with an exercise price of $4.50 using the binomial model is:

A) $ 1.0565 $
B) $ 1.1131 $
C) $ 1.1256 $
D) $ 1,3042$

Quizplus · Accepted Answer

If the asset price increases,it will increase to 5 F1F1F1S1F1F1F10 1.25 = 6.25.If the asset price decreases,it will go to 5 F1F1F1S1F1F1F10 (1/1.25)= 4.80.At the up price,the option can be exercised for a profit of $6.25 - 4.50 = $1.75.At the down price,the option will be exercised for a gain of $0.30.Given the values of u = 1.25,d = 0.80 and (1 + R)= 1.08,this gives values of alpha and (1 - alpha)of 0.6222 and 0.3778 respectively.The current option premium is therefore calculated as [(0.6222 F1F1F1S1F1F1F10 1.75)+ (0.3778 F1F1F1S1F1F1F10 0.30)]/1.08 = [1.0889 + 0.1133]/1.08 = 1.1131.

Assume a One-Period World with Current Share Price of $5 1.0565 1.0565 1.0565

Assume a One-Period World with Current Share Price of $5 $1.0565$