A one-year, simple zero-coupon bond with face value of $100 is currently worth

$95.833333... At the same time a two-year, zero-coupon bond with face value of $100 is

worth $92. Now, suppose you also know the following: one year from now, one-year bonds

will be worth either $94 or $98 with a probability of 50% for either value. a) Show that a call option that gives you the right to buy a one-year bond is currently

worth $0.479166. . The option can be exercised only one year from now and it has a

strike price of $97. Calculate the value of the option in each of two ways: i) by

constructing the hedge-portfolio, which is equivalent to the option and in) by the risk-

neutral method.

b) Suppose the price of one-year bond is $95 and not $95.833333, as previously stated.

What would happen to the call option value in this circumstance? Does it rise or fall

and why?