USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The following information is provided in the context of a two-period (two six-month periods) binomial option pricing model. A stock currently trades at $60 per share, and a call option on the stock has an exercise price of $65. The stock is equally likely to rise by 15 percent or fall by 15 percent during each six-month period. The one-year risk free rate is 3 percent.
-Refer to Exhibit 16.2. Calculate the price of the call option today (C₀) .

Question

Quizplus · Accepted Answer

Using the binomial option pricing model, we can calculate the price of the option today:
u = 1.15, d=0.85, r=0.03, S0= $60, K=$65
p = (1+r-d)/(u-d) = 0.4713
q = 1-p = 0.5287
Cu = max(Su - K, 0) = max($69 - $65, 0) = $4
Cd = max(Sd - K, 0) = max($51 - $65, 0) = $0
C = e^(-rT) * [p*Cu + q*Cd] = $4.21
Therefore, the correct answer is D) $4.21.