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Find the price of the call

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Reference no: EM133112088

1) BLBO stock currently sells for $72, and pays no dividend. You believe that at the end of each year, BLBO's up factor is 1.356, and its down factor is 0.541. Consider a European call option with an exercise price of $75, expiring in 2 years. The annual risk-free rate is 3%.

a) Use a no-arbitrage (dynamic hedging) strategy to find the price of the call today.

b) Suppose it is now one year later, and the stock moved up. Calculate the risk-neutral probability of another up move over the next year (i.e. year 1 to year 2). Use this risk neutral probability to derive the price of this call option in year 1. Remember, you should get the same value you derived along the way to your answer to a).

Reference no: EM133112088

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