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BINOMIAL MODEL The current price of a stock is $50. In 1 year, the price will be either $40 or $70. The annual risk-free rate is 4%. The stock has an exercise price of $55 and expires in 1 year. 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?

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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781285867977
BuyFind

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781285867977

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Chapter
Section
Chapter 18, Problem 9P
Textbook Problem

BINOMIAL MODEL The current price of a stock is $50. In 1 year, the price will be either $40 or $70. The annual risk-free rate is 4%. The stock has an exercise price of $55 and expires in 1 year.

  1. a. Find the range of values for the ending stock price and the call option at the option’s expiration in 1 year.
  2. b. Equalize the range of payoffs for the stock and the option.
  3. c. Create a riskless hedged investment. What is the value of the portfolio in 1 year?
  4. d. What is the cost of the stock in the riskless portfolio?
  5. 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?

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