Exhibit 14-3
USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT QUESTION(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, a call option on the stock has an exercise price of $65. The stock is equally likely to rise by 15% or fall by 15% during each six month period. The one-year risk free rate is 3%.
-Refer to Exhibit 14-3. Calculate the price of the call option today (C₀).
A) $7.77
B) $14.35
C) $0
D) $4.21
E) $6.44

Question

Quizplus · Accepted Answer

To solve for the value of the call today (C₀), first determine the number of calls by constructing a hedge portfolio where:
Right now:
Value of hedge portfolio if stock rises = Value of hedge portfolio if stock falls
69 + (7.7719)(n) = 51 + (0)(n)
n = -2.31603
Value of hedge portfolio now = 60 - (2.31603)(C₀) = 51/(1.0149)
C₀ = $4.2092

Exhibit 14-3 USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT QUESTION(S)