The stock price of ABC changes only once a month: either it goes up by 20% or it falls by 16.7%. Its price now is £40. The interest rate is 12.7% per year, or about 1% per month.   Required: i    Suppose a one-month call option on this stock has an exercise price of £40, what is the option delta? ii   Show how the payoffs of this call option can be replicated by buying ABC’s stock and borrowing. iii Using the risk-neutral method to calculate the value of a one-month call option with an exercise price of £40. iv  Construct a two-month binomial tree. What is the value of a two-month call option with an exercise price of £40?  v  Use put-call parity, what is the price for a one-month put with the same exercise price? And a two-month put with the same exercise price?

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
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The stock price of ABC changes only once a month: either it goes up by 20% or it falls by 16.7%. Its price now is £40. The interest rate is 12.7% per year, or about 1% per month.

 

Required:

i    Suppose a one-month call option on this stock has an exercise price of £40, what is the option delta?

ii   Show how the payoffs of this call option can be replicated by buying ABC’s stock and borrowing.

iii Using the risk-neutral method to calculate the value of a one-month call option with an exercise price of £40.

iv  Construct a two-month binomial tree. What is the value of a two-month call option with an exercise price of £40?

 v  Use put-call parity, what is the price for a one-month put with the same exercise price? And a two-month put with the same exercise price?

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