3. The current price of a non-dividend paying stock is So = $25 and its future p

Question

3. The current price of a non-dividend paying stock is So = $25 and its future price st is governed by the following equation: with = 0.06 and = 0.3. The riskfree interest rate is taken to be 6% per annum. (a) Calculate the price of a 6-months at-the-money European call option using risk neutral valuation principle (b) Calculate the current price of a 2-year digital option which the investors will receive A fixed payoff $10 if the stock price after 2 years lies between $15 and $25; A fixed payoff $20 if the stock price after 2 years lies between $35 and $45; Nothing if otherwise.

Explanation / Answer

Current price = $ 25

u=0.6 & 0.3

Risk free interest rate = 6%

price = 0.6/25

0.3/25

So = 25

total return = 35- 25= $10

Smililarly the price is $ 25 the value of put option will be $ 25

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