Options Solutions 1

Options Solutions 1 - each month. The monthly interest rate...

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Old Exam Problems - Options - Solutions Page 1 of 13 Pages Options - Solutions 1. American call options and European call options will sell for the same price, because: A. S - E > S - E / (1 + r) t * B. S - E < S - E / (1 + r) t C. S - E > S - E / (1 - r) t D. S - E < S - E / (1 - r) t E. They never sell for the same price American call options sell at the same price as European call options because although American call options allow one to exercise the option early, no one will choose to do that. This is because it will be worth more in the market prior to expiration than it will be to exercise. This is proven by answer B: S - E < S - E / (1 + r) t . 1. A stock is currently selling for $40. The stock price could go up by 8% or fall by 2%
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Unformatted text preview: each month. The monthly interest rate is 1% (periodic rate). Calculate the price of a call option on the stock with an exercise price of $40 and a maturity of two months. (use the binomial method) A. $3.60 B. $2.34 * C. $1.55 D. $0.69 E. None of the above u = 1.08; d = .98; P = (1.01 - .98)/(1.08 - .98) = .30; (1-P) = 1 - .30 = .70 P = $40 P 1 = ($40)(1.08) = $43.20 ($40)(0.98) = $39.20 P 2 = ($40)(1.08)(1.08) = $46.656 ($40)(1.08)(0.98) = $42.336 ($40)(0.98)(1.08) = $42.336 ($40)(0.98)(0.98) = $38.416 C uu = $46.656 - $40.00 = $6.656 C ud = $42.336 - $40.00 = $2.336 C du = $42.336 - $40.00 = $2.336 C dd = $38.416 - $40.00 = $0.000 C u = [(.3)($6.656) + (.7)($2.336)]/[1.01] = $3.596...
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