According to the Binomial Option Pricing Model example for Western Cellular, what is the price of the call option if the stock sells for $40, the strike price is $35, the risk-free rate is 8 percent, and the stock can end up at either $30 or $50 in one year?
Explanation
The Binomial Option Pricing Model calculates an option's price by constructing a riskless hedge portfolio (consisting of the underlying stock and the option) and requiring that this riskless portfolio earn the risk-free rate of return. The option price is the value that satisfies this no-arbitrage condition.
Other questions
What is the primary motivation for firms to engage in risk management, according to the text?
What is a key difference between a forward contract and a futures contract?
What is the definition of a call option?
In the context of the Black-Scholes Option Pricing Model, what is the effect of an increase in the stock's price volatility (variance) on the value of a call option, holding other factors constant?
What is the term for a debt obligation that is derived from some other debt obligation, such as zero coupon bonds created from Treasury bonds?
If a stock is trading at $30 per share, what is the exercise value of a call option on the stock with a strike price of $25?
What type of risk management strategy involves two parties with mirror-image risks entering a transaction to eliminate those risks?
What is the primary function of a swap agreement in finance?
In the context of risk management, what are pure risks?
What is the implied nominal annual interest rate on a 10-year U.S. T-notes futures contract that settled at a price of 103-060, or 103.1875 percent of par value?
What is the primary purpose of a 'riskless hedge' in the context of option pricing models?
What does a long hedge strategy using futures contracts aim to protect against?
What term describes the situation where the gain or loss on a hedged transaction exactly offsets the loss or gain on the unhedged position?
An inverse floater is a type of structured note. What is its key characteristic?
Based on the Black-Scholes Option Pricing Model, what is the value of a call option given the following data: Stock price is $33, strike price is $33, time to expiration is 6 months (0.50), risk-free rate is 10 percent, variance is 0.09, N(d1) is 0.63369, and N(d2) is 0.55155?
What is one of the primary reasons a firm might choose to hedge, even if investors can hedge on their own?
What is the premium on a call option if the stock sells for $31, the exercise price is $25, and the option's market price is $7?
Which of the following is NOT an assumption of the Black-Scholes Option Pricing Model?
If a U.S. firm needs to guard against a rise in interest rates for a future bond issuance, what would be an appropriate hedging strategy using futures?
In an interest rate swap, if Company S has a floating-rate bond and stable cash flows, while Company F has a fixed-rate bond and cyclical cash flows, what is the likely motivation for a swap?
When an investor sells a call option on a stock they already own, what is this action called?
Which risk management classification includes the risk that a firm's plant will be destroyed by a fire?
What does a call option's premium represent?
What is the term for a long-term option, with a maturity of up to 3 years, that is listed on exchanges and tied to individual stocks or stock indexes?
How does the risk-free interest rate affect the value of a call option, according to the Black-Scholes model?
What is the primary role of speculators in a derivatives market like the futures market for wheat?
What is the exercise value and premium for a call option with a strike price of $20, when the stock price is $22 and the option's market price is $10.50?
What is the term for risks that can be covered by insurance, such as property and liability risks?
When a firm plans to issue bonds but fears that interest rates will rise before the issuance, it would use which type of hedge?
What is self-insurance in the context of corporate risk management?
A call option on Boudreaux Company's stock has an exercise price of $14, an exercise value of $20, and a premium of $5. What are the option's market value and the stock's current price?
Why have derivative markets grown so rapidly in recent years?
A U.S. firm must pay 200 million Swiss francs in 90 days. If the 90-day forward exchange rate is 0.9509 francs per dollar, how many dollars will be required to honor the obligation?
What is the primary reason that a call option's premium over its exercise value declines as the stock price increases to high levels?
A firm is considering a call option on a stock. Which of the following events would be likely to decrease the market value of the call option?
What type of derivative contract is tailor-made, negotiated between two parties, and not traded on an exchange after being signed?
What is the primary risk associated with a 'naked option' position?
According to the text, why might a company like Porter Electronics, which uses copper as a raw material, buy copper futures contracts?
What does it mean for an option to be 'in-the-money'?
The Black-Scholes model calculates the value of an option as the difference between which two components?
According to the survey of CFOs mentioned in the text, what is the most highly-ranked benefit of risk management?
What is a key risk for the holder of an inverse floater note?
A put option on Yonan Communications stock has an exercise price of $60 and a market value of $2.90. What is the premium on the put option if the stock currently sells for $65?
Which of the following describes the process of 'marking to market' for a futures contract?
Which of the following is a key reason why risk management through hedging can add value to a firm, according to the text?
In the Binomial Model example, a riskless portfolio is created by buying 0.75 shares of stock and selling one call option. If the stock ends up at $50, what is the value of the option position to the seller?
According to the text, a major function of risk management involves evaluating all alternatives for managing a particular risk and then choosing the optimal one. Which of the following is considered an alternative to buying insurance?
What is the primary difference between a short hedge and a long hedge?
If a current stock price is $16, what is the value of a call option based on the Black-Scholes model, given an exercise price of $16, expiration of 6 months, risk-free rate of 8 percent, variance of 0.12, N(d1) = 0.61247, and N(d2) = 0.51628?