Question
Suppose that a company's stock price, X, will be $100 - /2 next period with probability p and $100 + /2 with probability 1-p, where
Suppose that a company's stock price, X, will be $100 - /2 next period with probability p and $100 + /2 with probability 1-p, where 0 < 200.The CEO of the company receives some of his compensation in stock options with a strike price of $110.
a. What is the expected value of the stock price next period?That is, what is E(X)?
b. If next period the stock price turns out to be the low price $100 - /2, for what range of will the CEO exercise the option?If next period the stock price turns out to be the high price $100 + /2, for what range of will the CEO exercise the option?
c. Letting V() denote the "expected value of 1 option" (which is expressed as a function of ), sketch a graph of V.Put V on the vertical axis and on the horizontal axis.Be sure to labeleverything(axes, any relevant points, kinks, slopes, etc.), and be sure to specify what the largest and smallest values of and V are on the graph.Assume p = when drawing the graph.
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