Question 7 [12 marks] OrangeMQ is a major smart mobile phone manufacturer which has recently releases its new product, Orange Phone 11 MAX. OrangeMQ claims that the new Orange- Phone 11 MAX is the most well-balanced and most capable phone which it has even made. The current price of one OrangeMQ share is $44.22. Over the next month the share price will either increase to $45.28 (if its new product has a positive market impact) or decrease to $42.96 (if its new product has a negative market impact). You are thinking of buying a European call option on shares of OrangeMQ A European call option on an OrangeMQ share will expire at the end of one month. The strike price is $44.50. OrangeMQ shares will not pay any dividends during the next month. You can borrow money today for one month at a rate of 112 = 4.8% p.a. a. [6 marks] Consider the replicating portfolio (that is, the investment strategy which will give identical payoffs, at the end of one month, to the call option) that involves buying h shares in OrangeMQ today, and borrowing $B for one month. Illustrate this model in a carefully labelled contingent cash flow diagram. Find the values of h and B (round your answers to five decimal places). b. [1 mark] What is the initial cost (net outlay) today of investing in the repli- cating portfolio? Round your answer to three decimal places. c. [2 marks] What is the fair price (or premium) for the call option? Why? Round your answer to three decimal places. d. [2 marks] The contingent payments method will give the same option value as the arbitrage pricing method, as long as the appropriate value is used for p (the probability of an upward price movement). Find the appropriate value of p in this case. (Round your answer to three decimal places.) e. [1 mark] Do we expect the call option price to increase or decrease if the strike price of this option is greater than $44.50? Question 7 [12 marks] OrangeMQ is a major smart mobile phone manufacturer which has recently releases its new product, Orange Phone 11 MAX. OrangeMQ claims that the new Orange- Phone 11 MAX is the most well-balanced and most capable phone which it has even made. The current price of one OrangeMQ share is $44.22. Over the next month the share price will either increase to $45.28 (if its new product has a positive market impact) or decrease to $42.96 (if its new product has a negative market impact). You are thinking of buying a European call option on shares of OrangeMQ A European call option on an OrangeMQ share will expire at the end of one month. The strike price is $44.50. OrangeMQ shares will not pay any dividends during the next month. You can borrow money today for one month at a rate of 112 = 4.8% p.a. a. [6 marks] Consider the replicating portfolio (that is, the investment strategy which will give identical payoffs, at the end of one month, to the call option) that involves buying h shares in OrangeMQ today, and borrowing $B for one month. Illustrate this model in a carefully labelled contingent cash flow diagram. Find the values of h and B (round your answers to five decimal places). b. [1 mark] What is the initial cost (net outlay) today of investing in the repli- cating portfolio? Round your answer to three decimal places. c. [2 marks] What is the fair price (or premium) for the call option? Why? Round your answer to three decimal places. d. [2 marks] The contingent payments method will give the same option value as the arbitrage pricing method, as long as the appropriate value is used for p (the probability of an upward price movement). Find the appropriate value of p in this case. (Round your answer to three decimal places.) e. [1 mark] Do we expect the call option price to increase or decrease if the strike price of this option is greater than $44.50
