Consider a stock worth $100 that can go up or down by 40 percent per period. The risk-free

rate is 2.72 percent. Use one binomial period.

a. Determine the two possible stock prices for the next period.

b. Determine the intrinsic values at expiration of a European call option with an exercise

price of $100.

c. Find the value of the option today.

d. Construct a hedge by combing a position in stock with a position in the call. Show

that the return on the hedge is the risk-free rate regardless of the outcome, assuming

that the call sells for the value you obtained in part c.

e. Determine the rate of the return from a riskless hedge if the call is selling for $21.50

when the hedge is initiated.

The following options prices were observed for calls and puts on Bull Ltd for the trading day

of July 6 2018. Use this information in Questions 3-8. The stock was priced at 163.37. The

expirations were July 17, August 21 and October 16. The continuously compounded risk-free

rates associated with the three expirations were 0.0517, 0.0542 and 0.0565, respectively. The

options have European expiries.

STRIKE 150 155 160 165 JUL 9.50 5.70 2.23 0.77 CALLS AUG 11.25 7.96 5.01 2.79 OCT 13.61 10.88 8.04 6.90 JUL 0.17 0.71 2.22 5.61 PUTS AUG 1.18 2.66 4.63 7.42 OCT 2.69 4.44 6.60 8.81 STRIKE 150 155 160 165 JUL 9.50 5.70 2.23 0.77 CALLS AUG 11.25 7.96 5.01 2.79 OCT 13.61 10.88 8.04 6.90 JUL 0.17 0.71 2.22 5.61 PUTS AUG 1.18 2.66 4.63 7.42 OCT 2.69 4.44 6.60 8.81