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Mumz [18]
3 years ago
15

Assume stock A costs $100 at t = 0 in a two-period world. There are two scenarios at t = 1: good and bad. In the good scenario t

he stock price rises to 120 dollars and in the bad scenario stock price declines to 70. The probability of both these scenarios is p = 0.5. The annual riskless rate is 10%. Your broker offers you a call option with strike price of $110 for $4.60. Will you take up his offer? Why or why not?
Business
1 answer:
Arada [10]3 years ago
3 0

Answer:

The offer at $4.60 by the broker is higher than the calculated fair value of $4.545 hence i will not take up his offer

Explanation:

Given data:

stock A = $100 at  t = 0  

in two worlds : good scenario ; stock A  = $120

                         bad scenario ; stock A = $70

probability = 0.5

annual risk less rate = 10% = 0.1

To determine if to take the offer or not we have to calculate the call option using the given parameters

Cu = \frac{(0.5*10) + (0.5*0)}{(1 + 0.10)}  = $4.545

The offer at $4.60 by the broker is higher than the calculated fair value of $4.545 hence i will not take up his offer

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