An Ivy League University Endowment Fund believes the stock price for Colleen's Cement Company (CCC) will increase substantially over the next 12 months. The current price is $72.00 per share. The endowment fund will use a call option to take advantage of this expected directional movement. There is a call option that has an expiration date of one year, and an exercise price of $75.00 per share. The risk-free rate of interest is 4.92%.

1. Compute the price of the option using the simple option pricing model.

2. Compute the price of the option using the Black Scholes Merton option pricing model if N(d1) = 0.563 and N(D2) = 0.464.

3. Compute the holding period return on the option if the price of the share of stock is $100 at the end of one year when the option expires.

4. Explain why the endowment fund would choose to buy the option over purchasing shares in CCC.

Answer rating: 100% (QA)

1 Compute the price of the option using the simple option pricing model The simple option pricing model is given by the formula Call Option Price max0 S X Where S Current stock price 7200 X Exercise p... View the full answer