Question
During the upcoming year, the stock price of DJ corporation is expected to go up to $290 or down to $170 with equal probabilities. The
During the upcoming year, the stock price of DJ corporation is expected to go up to $290 or down to $170 with equal probabilities. The beta of the stock is equal to 0.75. The annual risk free rate is 10.5%, and the expected annual return on the market is 16.5%. You are interested in replicating and pricing a European call option on DJs stock. The option has a strike price of $212, and will mature in one year.
1. What is the current price of DJs stock?
2. Using the stock and borrowing/lending (at the risk free rate), form a portfolio that will replicate the call option. How many shares of DJ will you buy/sell, and how much money will you borrow/lend?
3. Use the portfolio derived in part (2) to price the call option.
4. What is the beta and expected return of the call option?
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