Question 3

The price of an equity is RM5. Call and put options are available for this equity. The maturity of the options is at time Y. The stock price will change 3 times until maturity. The chance of the stock price going up is 70% while going down is 30%. The annualised risk-free rate between now and time Y is 5% and the equity risk is 15%.

Required:

(a)Draw a statistical diagramme showing the path of the stock prices and their terminal prices for call option worth RM5.00 maturing at time Y. Calculate the value of the call option based upon the Binomial Options Pricing Model (BOPM).(6 marks)

(b)If it is a put option with the same characteristics, what would be its value based upon BOPM ? Explain why the put option value is higher or smaller compared to the call option.(4 marks)