Question
A share now sells for $40.00. This price will either increase by 10% (by a factor of u = 1.10) or decrease by 20% (by
A share now sells for $40.00. This price will either increase by 10% (by a factor of u = 1.10) or decrease by 20% (by a factor of d = 0.80) over a six-month period. A European call option on this share has an exercise price of $42 and a time to expiry of six months. The risk-free rate is 6% per year. Call option price is 5.2
An analyst disagrees with the current share price movement predictions and believes that the share price will either increase by 20% or decrease by 30% over a six-month period. Assume that the European call option has the exercise price with $100 and the six months time to expiry.
d. Would the analyst price the European call option at, above, or below the original price calculated in Part c? Why? [Maximum: 200 words] [10 Marks]
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