22.

A. A stock index is currently trading at 50. Paul Tripp, CFA, wants to value two-year index options using the binomial model. In any year, the stock will either increase in value by 20% or fall in value by 20%. The annual risk-free interest rate is 6%. No dividends are paid on any of the underlying securities in the index.

Construct a two-period (two-year) binomial tree for the value of the stock index. In each year, the stock will either increase in value by 20% or fall in value by 20% and Calculate the value of a European call option on the index with an exercise price of 60

B. A call option with X = $50 on a stock currently priced at S = $55 is selling for $10. Using a volatility estimate of = .30, you find that N(d1) = .6 and N(d2) = .5. The risk-free interest rate is zero. Is the implied volatility based on the option price more or less than .30? Explain your answer