Suppose that demand for a product is Q = 1200 − 4P and supply is Q = −240 + 2P. Furthermore, suppose that the marginal external
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Answer:
$13.64
Explanation:
Given:
Exercise price,X = $100
Current price = $100
Value when price is up, uS = $120
Value when price is down, dS= $80
Risk free interest rate = 10%
First calculate hedge ratio, H:
Where,
Cu = uS - X
= 120 - 100
= $20
A risk free portfolio involves one share and two call options.
Find cost of portfolio:
Cost of portfolio = Cost of stock - Cost of the two cells.
= $100 - 2C
This portfolio is risk free. The table below shows that
_______________
Portforlio 1:
Buy 1 share $80; Write 2 calls: $0; Total: ($80 + 0) $80
____________________
Portforlio 2:
Buy 1 share: $120; Write 2 calls: -$40; Total: ($120 - $40) $80
Check for oresent value of the portfolio:
Present value
Value = exercise price - value of option
$72.73 = $100 - 2C
Find call option, C
Call option's value = $13.64