USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The information provided is relevant in the context of a one period (one year) binomial option pricing model. A stock currently trades at $50 per share, and a call option on the stock has an exercise price of $45. The stock is equally likely to rise by 25 percent or fall by 25 percent. The one-year, risk-free rate is 2 percent.
-Refer to Exhibit 16.5. Calculate the possible prices of the stock one year from today.
A) $37.50 or $17.50.
B) $62.50 or $37.50.
C) $62.50 or $17.50.
D) $50 or $45.
E) None of the above.

Question

Quizplus · Accepted Answer

The stock price can either increase by 25% or decrease by 25% from its current price of $50.

If the stock price increases by 25%, the new price will be:
$50 x (1 + 0.25) = $62.50

If the stock price decreases by 25%, the new price will be:
$50 x (1 - 0.25) = $37.50

Therefore, the possible prices of the stock one year from today are $62.50 or $37.50. Option B is the only choice that includes both of these prices.