The price of Build A Fire Corp. stock will be either $65 or $92 at the end of th

Question

The price of Build A Fire Corp. stock will be either $65 or $92 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 3 percent.

a. Suppose the current price of the company's stock is $72. What is the value of the call option if the exercise price is $60 per share? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Value of the call option $

b. Suppose the exercise price is $85 and the current price of the company's stock is $72. What is the value of the call option now? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Value of the call option

Explanation / Answer

2

u=92/72=1.278

d=65/72=0.902778

p=(e^(rt)-d)/(u-d)=(e^(0.03*1)-0.902778)/(1.278-0.902778)=0.340269

1-p=0.659731

Value of call option=e^(-3%*1)*(0.340269*max(65-85,0)+0.659731*max(92-85,0))=4.481631

u=92/72=1.278

d=65/72=0.902778

p=(e^(rt)-d)/(u-d)=(e^(0.03*1)-0.902778)/(1.278-0.902778)=0.340269

1-p=0.659731

Value of call option=e^(-3%*1)*(0.340269*max(65-60,0)+0.659731*max(92-60,0))=22.13852

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