Explanation:
In this case, U = 1.1, D = 0.9, r = 0.035, and the value of the option is $1 if the stock increases and $0 if the stock decreases. The probability of an up movement, πᵤ, can be calculated as (e^(0.035 × 3/12) − 0.9) / (1.1 − 0.9) = 0.5439. The value of the call option is therefore (0.5439 × $1) / e^(0.035 × 3/12) = $0.54.
(Book 4, Module 60.1, LO 60.a)
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Question 26
A stock currently trades at $10. At the end of three months, the stock will either be $11 or $9. The continuously compounded risk-free interest rate is 3.5% per year. Using a binomial tree, the value of a 3-month European call option with a strike price of $10 is closest to:
A
$0.11.
B
$0.54.
C
$0.65.
D
$1.01.
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