Mr. Neel holds share of AP Ltd. These shares are currently traded at ₹50. In a year's time, it is expected that it will be either ₹40 or ₹60. Government of India bonds carry interest rate of 8% p.a. What is the value of

Answer 4(b) Current Price of Share (S₀) = ₹50 Future Price ₹60 (S₁) or ₹40 (S₂); Exercise Price = ₹52 If the stock performs at ₹40, it will lapse at ₹52 and value = 0 If the stock performs at ₹60 and the exercise price is ₹52, then Call Value (C₁) = ₹60 - ₹52 = ₹8 Call Value (C₂) = 0 No. of calls to be bought = (S₁ - S₂) / (C₁ - C₂) = (60 - 40) / 8 = 2.5 Spot price (S₀) = Present value of lower price + Calls bought × C₀ Where C₀ = Value of Call option today 50 = [40 × 1 / (1.08)] + 2.5 × C₀ 50 = 37.04 + 2.5 × C₀ Hence, C₀ = 5.184