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Unformatted text preview: opean, it would not be possible to exercise early. Therefore,
if the price rises to $440 at month 6, the value of the option is $265, not $275 as is
the case for the American option. Therefore, in this case, the value of the
European option is less than the value of the American option. The value of the
European option is computed as follows: 8. The following tree (see Practice Question 5) shows stock prices, with the values for the
oneyear option values in parentheses: The put option is worth $55 in month 6 if the stock price falls and $0 if the stock price
rises. Thus, with a 6month stock price of $110, it pays to exercise the put (value = $55). With a price in month 6 of $440, the investor would not exercise the put since it would cost
$275 to exercise. The value of the option in month 6, if it is not exercised, is determined
as follows: Therefore, the month 0 value of the option is: 9. a. The following tree shows stock prices (with put option values in parentheses): Let p equal the probability that the stock price will rise. Then, for a riskneutral
investor: (p ´ 0.111) + (1 p)´(0.10) = 0.05 p = 0.71 If the stock price in month 6 is C$111.1, then the...
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