You are attempting to value a call option with an exercise price of $85 and one

Question

You are attempting to value a call option with an exercise price of $85 and one year to expiration. The underlying stock pays no dividends, its current price is $85, and you believe it has a 50% chance of increasing to $115 and a 50% chance of decreasing to $55. The risk -free rate of interest is 6%. Based upon your assumptions, calculate your estimate of the the call option's value using the two -state stock price model. (Do not round intermediate calculations. Round your answer to 2 decimal places.) Value of the call $

Explanation / Answer

u = 115/85 = 1.352941

d = 55/85 = 0.647059

r = 0.06

Cu = max(115-85,0) = 30

Cd = max(55-85,0) = 0

C0 = (1+r-d)/(u-d)*Cu/(1+r) + (u-1-r)/(u-d)*Cd/(1+r)

=(1+0.06-0.647059)/(1.352941-0.647059)*30/(1+0.06)

= 16.56

The answer is $16.56

Thanks.

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