Question

The common stock of Westover Foods is currently priced at $29.10 a share. One year from...

The common stock of Westover Foods is currently priced at $29.10 a share. One year from now, the stock price is expected to be either $27 or $33 a share. The risk-free rate of return is 2.8 percent. What is the current value of one call option on this stock if the exercise price is $30? A. $0 B. $1.42 C. $3.00 D. $.79 E. $2.83

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Answer #1

B. $1.42 ,

Current price of stock = number of option *  current value of one call option + [minimum share price / [1+ risk free rate]

$29.10 = 2 *current value of one call option + [$27 / 1+0.028]

$29.10 = 2 *current value of one call option + [$27 / 1.028]

$29.10 = 2 *current value of one call option + 26.26

$29.10 - $26.26 = 2 *current value of one call option

2.84 = 2 *current value of one call option

current value of one call option = $1.42

Note:- Number of option =[maximum share price - minimum share price] / [exercise price - minimum share price]

= [$33 - $27] / (30 - $27)

= $6 / $3

= 2

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