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Problem 4. Suppose that the risk-free rate is 4% per period. Consider an asset whose current price is $50. Suppose that its cum-dividend price in
Problem 4. Suppose that the risk-free rate is 4% per period. Consider an asset whose current price is $50. Suppose that its cum-dividend price in Period One is either 15% higher or 5% lower than $50. It is expected to pay a dividend of $2 at the end of Period One. Its price (ex-dividend) will drop by the amount of the dividend payment immediately afterwards. Period Two's cum-dividend price is either 15% higher or 5% lower than the Period One ex-dividend price. (a) What is the value of an American Call option on the asset if its exercise price is $48 and its expires at the end of Period Two? (b) What is the value of an European Call option on the asset if its exercise price is $48 and its expires at the end of Period Two? (c) What is the value of an American Put option on the asset if its exercise price is $52 and it expires at the end of Period Two? Problem 4. Suppose that the risk-free rate is 4% per period. Consider an asset whose current price is $50. Suppose that its cum-dividend price in Period One is either 15% higher or 5% lower than $50. It is expected to pay a dividend of $2 at the end of Period One. Its price (ex-dividend) will drop by the amount of the dividend payment immediately afterwards. Period Two's cum-dividend price is either 15% higher or 5% lower than the Period One ex-dividend price. (a) What is the value of an American Call option on the asset if its exercise price is $48 and its expires at the end of Period Two? (b) What is the value of an European Call option on the asset if its exercise price is $48 and its expires at the end of Period Two? (c) What is the value of an American Put option on the asset if its exercise price is $52 and it expires at the end of Period Two
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