The basic setup for all questions begins the same. Frederica Johnson has been offered the position as CIO of a large public technology company. As part of the deal, Frederica has been offered employee stock options in the company. The details of the option offer is as follows: The package is for 250,000 options over the companys stock The strike price of each options has been set at $120 that is the current stock price of the company meaning the options have been priced at-the-money The options are European and mature in 5 years For the purpose of this questions, the annualized volatility of the companys stock has been estimated at 30% The company does not pay a dividend and is not expected to over the next five years An appropriate annualized risk-free rate is 1.0% (professors current favorite)

Question: Use a binomial tree approach to value the same options please use years as the basic unit of time, meaning your tree should contain 5 steps.

a) What are the up and down factors for constructing the tree (values u and d in my examples)?

b) Construct the price tree for the underlying stock using the opening stock price given, and the up and down factors calculated in a).

c) At the terminal nodes of the tree, what is the option worth?

d) What are the risk-neutral probabilities p and 1 p?

e) Using the terminal node values, the risk-neutral probabilities, and the risk-free rate, construct the equivalent price tree for the option. f) What is the value of the option using this approach?

Question: Using the C-R-R equation, calculate the value of the option.