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Consider a stock worth $25 that can go up or down by 15 percent per period. The risk-free rate is 10 percent. Use one binomial period.

a. Determine the two possible stock prices for the next period.

b. Determine the intrinsic values at expiration of a European call option with an exercise price of $25.

c. Find the value of the option today.

d. Construct a hedge by combining a position in stock with a position in the call. Show that the return on the hedge is the risk-free rate regardless of the outcome, assuming that the call sells for the value you obtained in part c.

e. Determine the rate of return from a riskless hedge if the call is selling for $3.50 when the hedge is initiated.

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Financial Management, Finance

Category:- Financial Management
Reference No.:- M92078932

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