The price of Swearengen, Inc., stock will be either $71 or $93 at the end of the

Question

The price of Swearengen, Inc., stock will be either $71 or $93 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 3 percent.

Suppose the current price of the company's stock is $82. What is the value of the call option if the exercise price is $67 per share? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Suppose the current price of the company's stock is $82. What is the value of the call option if the exercise price is $77 per share? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

The price of Swearengen, Inc., stock will be either $71 or $93 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 3 percent.

Explanation / Answer

Part A:

The value of the call is the stock price minus the present value of the strike (exercise price), so:

C0 = $82 – $67/1.03

C0= $16.95

Part B

Using the equation presented in the text to prevent arbitrage, we find the value of the call is:

$82 = 2C0 + $71/1.03

C0 = $6.53

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