The stock of a computer company is currently trading at a market price of $60 pe
ID: 2706607 • Letter: T
Question
The stock of a computer company is currently trading at a market price of $60 per share. During the next two years the return on the computer company's stock will have a yearly standard deviation of 45%. The risk free rate of interest is 3% per year compounded continously. An American call option on the company having a strike price of $57.50 and 18 months to expiration has a hedge ratio of .6681. The risk adjusted probability that the 18 month $57.50 call option will finish in the money is .4535. Assuming the company is NOT expected to pay a DIVIDEND during the next two years, determine
a. the value of an American Call Option on the company with 18 months to expiration and a $57.50 strike price.
b. the risk-adjusted probability that a European put option on Braeburn having 18 months to expiration and a strike price of $57.50 will finish in the money.
c. the value of an European put option on the company having 18 months to expiration and a strike price of $57.50.
Explanation / Answer
The total return measures the increase or decrease in wealth that an investor achieves from holding a particular investment. Focusing on only the income component or the capital gain or loss component can potentially miss an important determinant of an investor