27. Option Pricing. Look again at the Google call option that we valued in Section 23.2. Suppose that by the end of June 2008 the price of Google stock could double to $1,440 or halve to $360. Everything else is unchanged from our example. (LO2)

a. What would be the value of the Google call at the end of June 2008 if the stock price is $1,440? If it is $360?

b. Show that a strategy of buying three calls provides exactly the same payoffs as borrowing the present value of $720 from the bank and buying two shares.

c. What is the net cash flow in December 2007 from the policy of borrowing PV($720) and buying two shares?

d. What does this tell you about the value of the call option?

e. Why is the value of the call option different from the value that we calculated in Section 23.2? What does this tell you about the relationship between the value of a call and the vola- tility of the share price?