Determine the value of the call option

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Assume risk-neutrality. A European call option with a strike price of $20.40 which expires in four months is written over a stock that is currently priced at $20.00. It is known that at the end of four months the stock will be either worth $18 or $22. The risk-free interest rate is 5% p.a. (continuously compounded).

Question i) Verify that the probability of a share price increase is 0.584.

Question ii) Use the risk-neutral valuation method to determine the value of the call option.

Reference no: EM132595139

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