The value of an option can be calculated by using a step-by-step approach in the case of single periods or by using sophisticated formulas that can be easily created through a spreadsheet. In the real world, two possible outcomes for a stock price in six months is an assumption. The stock markets are volatile, and stocks move up and down based on market- and firm-specific factors. Consider the case of Toronto Cell Inc.: Shares of Toronto Cell Inc., a manufacturer of cell phones, sell for $30.00. Existing options allow for the option holder to purchase one additional share at an exercise price of $25.00. (Assume that you get the option for free!) The option will expire within one year. Assume that at that time there will be an 80% chance that Toronto Cell Inc. shares will sell for $45.00 and a 20% chance that the shares will be selling at $20.00. Based on the binomial approach, the expected end-term share price and return on Toronto Cell Inc. shares are: Based on the binomial approach, the range of payoff values at expiration for Toronto Cell Inc.'s shares and options is:

The value of an option can be calculated by using a step-by-step approach in the case of single periods or by using sophisticated formulas that can be easily created through a spreadsheet. In the real world, two possible outcomes for a stock price in six months is an assumption. The stock markets are volatile, and stocks move up and down based on market- and firm-specific factors. Consider the case of Toronto Cell Inc.: Shares of Toronto Cell Inc., a manufacturer of cell phones, sell for $30.00. Existing options allow for the option holder to purchase one additional share at an exercise price of $25.00. (Assume that you get the option for free!) The option will expire within one year. Assume that at that time there will be an 80% chance that Toronto Cell Inc. shares will sell for $45.00 and a 20% chance that the shares will be selling at $20.00. Based on the binomial approach, the expected end-term share price and return on Toronto Cell Inc. shares are: Based on the binomial approach, the range of payoff values at expiration for Toronto Cell Inc.'s shares and options is:

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter8: Financial Options And Applications In Corporate Finance

Section: Chapter Questions

Problem 5MC: In 1973, Fischer Black and Myron Scholes developed the Black-Scholes option pricing model (OPM). (1)...

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