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# Binomial - Risk neutral probability and value of call option

17. A stock price is currently \$100. Over each of the next two three-month periods it is expected to increase by 10% or fall by 10%. Consider a six-month European call option with a strike price of \$105. The risk-free rate is 8%. What is the risk-neutral probability of a 10% rise in both quarters?
a. 0.10
b. 0.24
c. 0.36
d. 0.60
e. 0.84

18. A stock price is currently \$100. Over each of the next two three-month periods it is expected to increase by 10% or fall by 10%. Consider a six-month European call option with a strike price of \$105. The risk-free rate is 8%. What is the value of the call option?
a. \$6.25
b. \$5.55
c. \$5.00
d. \$4.50
e. \$4.05

#### Solution Preview

See the attached file. The correct answers are c 0.36 and b 5.55

A stock price is currently \$100. Over each of the next two three-month periods it is expected to increase by 10% or fall by 10%. Consider a six-month European call option with a strike price of \$105. The risk-free rate is 8%. What is the risk-neutral probability of a 10% rise in the first ...

#### Solution Summary

Illustrates the use of binomial tree model for calculation of Risk neutral probability and value of call option with two conceptual questions. Solution provide detailed answers.

\$2.19