If the interest rate is 8%, what is the risk-neutral valuation of the call optio
ID: 2759113 • Letter: I
Question
If the interest rate is 8%, what is the risk-neutral valuation of the call option specified in Exercise 7.2?
I am writing exercise 7.2 below.
The prices of a certain security follow a geometric Brownian motion with parameters = 0.12 and = 0.24. If the security’s price is presently 40, what is the probability that a call option, having four months until its expiration time and with a strike price of K = 42, will be exercised? (A security whose price at the time of expiration of a call option is above the strike price is said to finish in the money.)
Explanation / Answer
Answer Risk neutral valuation Share price $40.00 Risk free Interest Rate 8.00% Tenure 4 months '= 40*8%*4/12 Risk neutral valuation '= 1.07