Question

The price of TSC stock will be either $42 or $46 at the end of the year. Currently, T-bills yield 4.1 percent and TSC sells for $43 a share. What is the per share value of a one-year TSC call option if the exercise price is $45 per share?

a. $1.03
b. $.66
c. $.72
d. $.81
e. $0

Answer 1

Answer:

b. $.66

Explanation:

The computation of the per share value for the one year is

Given that

Current Price = $43

Possible Prices = $42 and $46

Now

u = [($46 - $43) ÷ $43] + 1

= 1.06977

And

d = 1 - [($42 - $43) ÷ $43]

= 0.9767

And,

Risk-Free Rate = T-Bill Rate = Rf = 4.1 %

Now the up move price probability is

= [(1 + Rf) - d] ÷ [u - d]

= [(1.041) - 0.9767] ÷ [1.06977 - 0.9767]

= 0.69088

And,  

Exercise Price = $ 45

Now

If the Price is $42, so Payoff = $0

And

if the Price is $46, so Payoff =is

= ($46 - $45)

= $1

Finally the call price is

= [0.69088 × 1 + (1 - 0.69088) × 0] ÷ 1.041

= $0.66367

= $0.66