You are offered a European Call option. This means you will have the option, but not...

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Finance

You are offered a European Call option. This means youwill have the option, but not the
obligation, to buy the stock at the strike price K of$100.
The price of the stock today is
$90. Your time discount rate is Beta=0.98, the risk-less rate ofinterest is 3%.

The price of the stock follows the following process overtwo periods: with probability
75% the price will not change from period 0 to period 1, but withprobability 25% will go
up to $130. Then from period 1 to period 2, with probability 25%the price will stay the
same, and with probability 75% the price will go down by 20%.
How much would you be willing to pay as of period 0 for thisoption
Show work please!

Answer & Explanation Solved by verified expert

3.7 Ratings (339 Votes)

Please see the stock price tree along with joint probability ofeach pathPayoff from call option at the end of period 2 max S2 See Answer

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Transcribed Image Text

You are offered a European Call option. This means youwill have the option, but not theobligation, to buy the stock at the strike price K of$100.The price of the stock today is$90. Your time discount rate is Beta=0.98, the risk-less rate ofinterest is 3%.The price of the stock follows the following process overtwo periods: with probability75% the price will not change from period 0 to period 1, but withprobability 25% will goup to $130. Then from period 1 to period 2, with probability 25%the price will stay thesame, and with probability 75% the price will go down by 20%.How much would you be willing to pay as of period 0 for thisoptionShow work please!