A stock price has an expected return of 16% and a volatility of 35%. The current price is $38. What is the probability that a European call option on the stock with an exercise price of $40 and a maturity date in six months will be exercised? What is the probability that a European put option on the stock with the same exercise price and maturity will be exercised?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
A stock price has an expected return of 16% and a volatility of 35%. The current price is $38.
- What is the probability that a European call option on the stock with an exercise price of $40 and a maturity date in six months will be exercised?
- What is the probability that a European put option on the stock with the same exercise price and maturity will be exercised?
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