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Suppose that firm D's shares are currently selling for $50. After six months it is estimated...

Suppose that firm D's shares are currently selling for $50. After six months it is estimated that the share price will either rise to $56.00 or fall to $44.75. If the share price rises to $56.00 in six months, six months from that date (1 year from today) the price is estimated to either rise to $62.72 or fall to $50.12. If the share price falls to $44.75 in six months, six months from that date (1 year from today) the price is estimated to either rise to $50.12 or fall to $40.05. The six month risk free rate is 2.5%.

Based on the tree diagram of stock prices, what is the risk neutral probability of a share price increase over either six month subperiod?

Multiple Choice

· .5475

· .5245

· .5778

· .5675

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Answer #1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

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