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quiz_solve06 - 4. What is the value of the option?...

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FNCE 3010 (Durham). Quiz 6. Suppose the current stock price is $80 and the price in one year will be either $70 or $120. The risk-free rate is 5%. Consider a call option with one year to maturity and a strike price of $90? 1. What are the possible payoffs of the option? 2. How can you construct a risk-free hedge portfolio using options and shares of the underlying security? 3. What is the present value of the risk-free portfolio?
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Unformatted text preview: 4. What is the value of the option? Solution: 1. $30 or $0. 2. The hedge ratio is = 30-120-70 = . 60 So, buy .60 shares of stock and write one option. 3. This portfolio has a payo of $42 (in either scenario). The present value is 42/1.05 = 40. 4. The value of the call option must be .6*80 - 40 = $8....
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