Question
An economist writes a 1-period expectation model for valuing options. The model assumes that the stock starts at 20 and moves up or down by
An economist writes a 1-period expectation model for valuing options. The model assumes that the stock starts at 20 and moves up or down by 25% in one year’s time with equal probability. Assume interest rates are zero.
(a) Using this expectation model what is the value of a call option struck at 22?
(b) Now use the 1-period model to calculate the risk-neutral probabilities and thus calculate the risk-neutral value of this call option.
(c) (i) Calculate the percentage return on the option premium in the case the option ends in-the-money.
(ii) What is the expected return? [Bonus: Can you explain your answer?]
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Introduction to Management Science
Authors: Bernard W. Taylor
12th edition
133778843, 978-0133778847
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