Chapter 18, Problem 8P

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

Chapter
Section

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

# BINOMIAL MODEL Misuraca Enterprise’s current stock price is $45 per share. Call options for this stock exist that permit the holder to purchase one share at an exercise price of$50. These options will expire at the end of 1 year, at which time Misuraca's stock will be selling at one of two prices, $35 or$55. The risk-free rate is 55%. As an assistant to the firm’s treasurer, you have been asked to perform the following tasks to arrive at the value of the firm's call options. a. Find the range of values for the ending stock price and the call option at the option's expiration in 1 year. b. Equalize the range of payoffs for the stock and the option. c. Create a riskless hedged investment. What is the value of the portfolio in 1 year? d. What is the cost of the stock in the riskless portfolio? e. What is the present value of the riskless portfolio? f. From your answers in parts d and e, what is the value of the firm's call option?

a.

Summary Introduction

To determine: The range of values for the ending price of stock and call option.

Introduction:

A type of security in a company that denotes ownership is termed as stock. Every company can raise capital funds by issuing stocks.

Explanation

Given information:

M Company’s current price of stock is $45 per share. The exercise price of the call option is$50 and the option expires in 1 year and the risk-free rate is 5.5 percent. The company’s stock will be sold for 2 prices that are $35 or$55.

The formula to compute the range is as follows:

Range=Ending PriceExercise price

Compute the range of values for the ending price of stock and call option:

The table

b.

Summary Introduction

To determine: The range of payoff for option and stock.

Introduction:

Option is a contract to purchase a financial asset from one party and sell it to another party on an agreed price for a future date.

c.

Summary Introduction

To determine: The value of portfolio in one year by creating a riskless hedged investment.

Introduction:

A set of financial investments owned by the investor is termed as Portfolio.

d.

Summary Introduction

To determine: The cost of the stock in the riskless portfolio.

e.

Summary Introduction

To determine: The present value of riskless portfolio.

f.

Summary Introduction

To determine: The value of call option of the firm.

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