The price of Ervin Corp. stock will be either S74 or $96 at the end of the year.

Question

The price of Ervin Corp. stock will be either S74 or $96 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 5 percent. Suppose the current price of Ervin stock is S80. What is the value of the call option if the exercise price is $70 per share? (Do not round intermediate calculations and round your final answer to 2 decimal places, (e.g., 32.16)) Value of the call option $ Suppose the exercise price is $90 and Ervin stock is $80. What is the value of the call option now? (Do not round intermediate calculations and round your final answer to 2 decimal places, (e.g., 32.16)) value of the call option

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Part A:

Value of Call Option = (80 - 70)/1.05 = $9.52

Answer is $9.52.

Part B:

Value of the Call Option Now = 80*1/2 - (74*1/2)/(1.05) = 40 - 35.24 = $4.76

Answer is 9.52.

Thanks.

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