A current price of a stock is $22 and the end of one year its price will be eith
ID: 2642957 • Letter: A
Question
A current price of a stock is $22 and the end of one year its price will be either $27 or $17. The annual risk free rate is 6.0% based on daily compounding. A 1-year call option on the stock with an exercise price of $22 is available. Based on the binominal model, what is the options value?
A. $2.99
B. $2.70
C. 2.43
D. 3.29
E. $3.62
These are the only options give on the practice quiz, and I'm not getting any of these answers. The closest I get is $3.01, and I'm not even sure if that is right. Help!
Explanation / Answer
Value of option today= C1*P+(C2*(1-p)/(1+r)
Probability(P)=spot price(1+interest rate)-lower price/higher price-lower price
=22(1+.06)-17/27-17
P =.632
1-P =.368
maturity price premium value of call on expiry probability expected value
27 5 .632 3.16
17 0 .368 0
value as call as on expiry 3.16
value of call option 3.16*1/1.06)
=$2.99
so value of call option is A=$ 2.99
value of option =