A house in Melbourne has recently sold for $2.5 million. Renting an equivalent house costs $250,000 per year (paid at year-end). The risk-free rate is 7.5% (annually compounded). Suppose the house can either increase in price each year by 20% or decrease by 20% before rent is paid out (i.e. cum-dividend). For example, the price can increase from $2.5 million to $3.0 million, so that after $250,000 rent is paid out (i.e. ex- dividend), the house is worth $2.75 million. i. What is the price of a 2-year at-the money American call option on the house? State any assumptions you need to make
A house in Melbourne has recently sold for $2.5 million. Renting an equivalent house costs $250,000 per year (paid at year-end). The risk-free rate is 7.5% (annually compounded). Suppose the house can either increase in price each year by 20% or decrease by 20% before rent is paid out (i.e. cum-dividend). For example, the price can increase from $2.5 million to $3.0 million, so that after $250,000 rent is paid out (i.e. ex- dividend), the house is worth $2.75 million. i. What is the price of a 2-year at-the money American call option on the house? State any assumptions you need to make
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:A house in Melbourne has recently sold for
$2.5 million. Renting an equivalent house
costs $250,000 per year (paid at year-end).
The risk-free rate is 7.5% (annually
compounded). Suppose the house can either
increase in price each year by 20% or
decrease by 20% before rent is paid out (i.e.
cum-dividend). For example, the price can
increase from $2.5 million to $3.0 million, so
that after $250,000 rent is paid out (i.e. ex-
dividend), the house is worth $2.75 million. i.
What is the price of a 2-year at-the money
American call option on the house? State any
assumptions you need to make
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