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Consider an American call option on a dividend paying stock when: - the current stock price is $6.00. - the exercise price is $5.00. -

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Consider an American call option on a dividend paying stock when: - the current stock price is $6.00. - the exercise price is $5.00. - the volatility is 30% p.a. - the risk-free rate of interest (continuous compounding) is 10% p.a. - the time to expiry is 3 months. - the stock is expected to pay a certain dividend of $1 in 121 (one and one-half) months' time. (note that 1/2 month =1/24 year.) Required: Use a three-period binomial option pricing model to value the three-month American call option with the life of the option divided into three equal 1-month periods. Use the methods discussed in Topic 8: - Calibrate "Up" and "down" moves (u and d) in one interval so that the binomial option price would converge to the Black-Scholes-Merton option price as the number of intervals increases. - Use the adjustment method for dividends to ensure that the trees recombine. Show detailed calculations of the option value at each node. For example, name each node, A, B,C, and show calculations for each node labelled "Node A", "Node B", and so on. Consider an American call option on a dividend paying stock when: - the current stock price is $6.00. - the exercise price is $5.00. - the volatility is 30% p.a. - the risk-free rate of interest (continuous compounding) is 10% p.a. - the time to expiry is 3 months. - the stock is expected to pay a certain dividend of $1 in 121 (one and one-half) months' time. (note that 1/2 month =1/24 year.) Required: Use a three-period binomial option pricing model to value the three-month American call option with the life of the option divided into three equal 1-month periods. Use the methods discussed in Topic 8: - Calibrate "Up" and "down" moves (u and d) in one interval so that the binomial option price would converge to the Black-Scholes-Merton option price as the number of intervals increases. - Use the adjustment method for dividends to ensure that the trees recombine. Show detailed calculations of the option value at each node. For example, name each node, A, B,C, and show calculations for each node labelled "Node A", "Node B", and so on

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