Question
An Ivy League University Endowment Fund believes the stock price for Colleen's Cement Company (CCC) will increase substantially over the next 12 months. The current
An Ivy League University Endowment Fund believes the stock price for Colleen's Cement Company (CCC) will increase substantially over the next 12 months. The current price is $72.00 per share. The endowment fund will use a call option to take advantage of this expected directional movement. There is a call option that has an expiration date of one year, and an exercise price of $75.00 per share. The risk-free rate of interest is 4.92%.
1. Compute the price of the option using the simple option pricing model.
2. Compute the price of the option using the Black Scholes Merton option pricing model if N(d1) = 0.563 and N(D2) = 0.464.
3. Compute the holding period return on the option if the price of the share of stock is $100 at the end of one year when the option expires.
4. Explain why the endowment fund would choose to buy the option over purchasing shares in CCC.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
1 Compute the price of the option using the simple option pricing model The simple option pricing model is given by the formula Call Option Price max0 S X Where S Current stock price 7200 X Exercise p...Get Instant Access to Expert-Tailored Solutions
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Step: 2
Step: 3
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