Explanation:
To find the value of the call, we need to do three things:
At time 1, the stock is estimated to be $23.48, so the value of the option at time 1 is $23.48 − $20.00 = $3.48 (note that the call has no value if the price falls).
Call value = ($3.48 × 0.55) / e⁰·⁰³ = $1.914 / 1.0304 = $1.86
(Book 4, Module 60.1, LO 60.a)
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Question 64
Assume a stock has a standard deviation of 16%, the continuously compounded risk-free rate is 3%, and the initial stock price is $20. Also, assume that the one-period upward stock price is 23.48 and the risk-neutral probability of an upward movement is 0.55. If a call option on the stock has a strike of $20, what is the estimated value of the call using the binomial methodology?
A
$1.99.
B
$2.15.
C
$1.86.
D
$2.35.
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