Question
Consider the price of an energy stock that either moves up 15% or moves down 15% every year. Part of the compensation of the CEO
Consider the price of an energy stock that either moves up 15% or moves down 15% every year. Part of the compensation of the CEO of this company is 100,000 3-year call option contracts on the stock price. The strike price of each option contract is $110. This stock has no options in the market. The CFO must design a portfolio (stock, risk-free bond) to replicate the payoff of the options. Assume that the risk-free rates are given by the spot treasury rates in question 2, and the current stock price is $100. Use annual binomial trees. If you cannot get the Treasury spot rates, then assume that the annualized risk-free rates are: 0% 1-year zero bond, 1% 2-year zero bond, and 3% 3-year zero bond. a. [10 points] How many shares of the stock the CFO must hold every year to replicate the option payoff? b. [10 points] What is the value today of the option compensation package of the CEO
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