23-88 If the manager buys a one-year option with an exercise price equal to the expected price of the bond in one year,what will be the exercise price of the option?

Question

Quizplus · Accepted Answer

The exercise price of the option should be equal to the expected price of the bond in one year. The expected price can be calculated as the average of the possible prices weighted by their probabilities. Using the table provided, we have:

Expected price = (0.05 x $85) + (0.15 x $85.50) + (0.30 x $86) + (0.25 x $86.50) + (0.25 x $87) 
Expected price = $86.21

Therefore, the exercise price of the option should be $86.21. The closest option price to this is choice (C), $86.21.

23-88 If the Manager Buys a One-Year Option with an Exercise