# 30 Suppose You Buy A Call Option Of A Firm S Stock The Current Price Of The Stock I 3300865

(30%) Suppose you buy a call option of a firm’s stock. The current price of the stock is \$60, but the price will change next period, with a probability 70% of increasing to \$120, and with a probability 30% of decreasing to \$30. The exercise price for this call option is \$70 at expiration (next period). Assume the interest rate is 5%. a) What is the present value of your expected profit? (Remember that is the price of the call option in today’s dollars) b) Now consider a three-period case: Suppose the stock price in the first period is still \$60. In the second period, the stock price will increase to \$120 with a probability 70%, and this price will continue to change in the third period, with a probability 40% of increasing to \$150 and a probability 60% of decreasing to \$100; in the second period, the stock price will go down to \$30 with a probability 30%, and this price will also continue to change in the third period, with a probability 40% of going up to \$65 and a probability 60% of going down to \$20. The call option you buy will expire in the third period and the exercise price is still \$70. The interest rate is still assumed to be 5%. Calculate the present value of your expected profit