A stock has a 15 percent change of moving either up or down per period and is currently priced at $25. Using a one period binomial model, and assuming that the risk-free rate is 10 percent, complete the following. a. Determine the possible stock prices at the end of the first period. b. Calculate the intrinsic values at expiration of an at-the-money European call option. c. Find the value of the option today.

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
icon
Related questions
Question
3.
A stock has a 15 percent change of moving either up or down per period and is currently
priced at $25. Using a one period binomial model, and assuming that the risk-free rate
is 10 percent, complete the following.
a. Determine the possible stock prices at the end of the first period.
b. Calculate the intrinsic values at expiration of an at-the-money European call option.
c. Find the value of the option today.
d. Construct a hedge by combining a position in stock with a position in the call. Show
that the return on the hedge is the risk-free rate regardless of the outcome, assuming
that the call sells for the value you obtained in c.
e. Determine the rate of return from a riskless hedge if the call is selling for $3.50
when the hedge is initiated.
Transcribed Image Text:3. A stock has a 15 percent change of moving either up or down per period and is currently priced at $25. Using a one period binomial model, and assuming that the risk-free rate is 10 percent, complete the following. a. Determine the possible stock prices at the end of the first period. b. Calculate the intrinsic values at expiration of an at-the-money European call option. c. Find the value of the option today. d. Construct a hedge by combining a position in stock with a position in the call. Show that the return on the hedge is the risk-free rate regardless of the outcome, assuming that the call sells for the value you obtained in c. e. Determine the rate of return from a riskless hedge if the call is selling for $3.50 when the hedge is initiated.
Expert Solution
trending now

Trending now

This is a popular solution!

steps

Step by step

Solved in 2 steps with 2 images

Blurred answer
Knowledge Booster
Options
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
  • SEE MORE QUESTIONS
Recommended textbooks for you
Essentials Of Investments
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
FUNDAMENTALS OF CORPORATE FINANCE
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:
9781260013962
Author:
BREALEY
Publisher:
RENT MCG
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Foundations Of Finance
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education