Madeline Manufacturing Inc.s current stock price is $35 per share. Call options for this stock exist that permit the holder to purchase one share at an exercise price of $30. These options will expire at the end of 1 year, at which time Madelines stock will be selling at one of two prices $20 or $40. The risk-free rate is 5%. Using the binomial option pricing model, create a riskless hedged investment and answer the following question: After the payoffs have been equalized and the riskless hedged investment is created, what is the value of the portfolio in one year? Round your answer to the nearest cent.

Answer is 10

Step 1: Find the range of values at expiration. Ending Ending stock value option value Ending Step 3: Create a riskless hedged investment. portfolio value Ending Ending stock value option value Ending portfolio value $40.00 $10.00 $30.00 $20.00 $10.00 $10.00 Current stock price Current option price Current stock price Current option price $35.00 $17.50 ? Ending Ending stock value option value Ending portfolio value $20.00 $20.00 $0.00 Ending Ending stock value option value Ending portfolio value Range outcomes: $20.00 $10.00 $10.00 $10.00 $0.00 $10.00 Range outcomes: $10.00 $10.00 $0.00 Step 2: Equalize the range of payoffs for the stock and the option. Equalize ranges: 0.5000 buy 0.5000 shares and sell 1 option Step 1: Find the range of values at expiration. Ending Ending stock value option value Ending Step 3: Create a riskless hedged investment. portfolio value Ending Ending stock value option value Ending portfolio value $40.00 $10.00 $30.00 $20.00 $10.00 $10.00 Current stock price Current option price Current stock price Current option price $35.00 $17.50 ? Ending Ending stock value option value Ending portfolio value $20.00 $20.00 $0.00 Ending Ending stock value option value Ending portfolio value Range outcomes: $20.00 $10.00 $10.00 $10.00 $0.00 $10.00 Range outcomes: $10.00 $10.00 $0.00 Step 2: Equalize the range of payoffs for the stock and the option. Equalize ranges: 0.5000 buy 0.5000 shares and sell 1 option