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Consider a two-year European call option on Mars Corp shares. The option has a strike price of $110.00, the Mars Corp stock price is currently
Consider a two-year European call option on Mars Corp shares. The option has a strike price of $110.00, the Mars Corp stock price is currently $100.00 and no dividends are expected to be paid on the stock over the next two years. Further, there is a 40% probability that the stock price will increase by 10% per annum and a 60% probability that the stock price will decrease by 10% per annum. The risk-free rate is 5% per annum. Using a two-period binomial model you calculate the current value the option to be $5.69 You now notice that the current market price of the option is $7.00 and so you decide to immediately set up a strategy (by trading in one option and an appropriate combination of stock and bonds) to take advantage of the arbitrage opportunity. What should you do in one year's time if the Mars Corp stock price at that time is $110.00 ? Consider a two-year European call option on Mars Corp shares. The option has a strike price of $110.00, the Mars Corp stock price is currently $100.00 and no dividends are expected to be paid on the stock over the next two years. Further, there is a 40% probability that the stock price will increase by 10% per annum and a 60% probability that the stock price will decrease by 10% per annum. The risk-free rate is 5% per annum. Using a two-period binomial model you calculate the current value the option to be $5.69 You now notice that the current market price of the option is $7.00 and so you decide to immediately set up a strategy (by trading in one option and an appropriate combination of stock and bonds) to take advantage of the arbitrage opportunity. What should you do in one year's time if the Mars Corp stock price at that time is $110.00
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