One of Modular Products (MP) customers would like to obtain a 6-month option to purchase 500,000 tables for $119 each. These tables currently sell for $110 each. Assume u equals 1.0994 and d equals. 9096. What price should MP charge for this option if the annual risk-free rate is 3.2 percent

Group of answer choices

a. $338,400

b. $421,900

c. $598,100

d. $479,900

e. $533,600

Option E is correct one.

$533,600

Explanation:

% increase = u - 1

% increase = 1.0994 - 1

% increase =.0994, or 9.94%/large % increase = u - 1

% decrease = d - 1

% decrease =.9096 - 1

% decrease = -.0904, or - 9.04%

Price with increase = $110 (1.0994)

Price with increase = $120.934

Price with decrease = $110 (.9096)

Price with decrease = $100.056

rf = Probability of rise (Increase percent) + (1 - Probability of rise) (Decrease percent)

.032 (6/12) = Probability of rise (.0994) + (1 - Probability of rise) (-.0904)

Probability of rise =.5606, or 56.06%

Probability of fall = 1 -.5606

Probability of fall =.4394, or 43.94%

Payoff if price increases = $120.934 - 119

Payoff if price increases = $1.934

Payoff if price decreases = $0

Expected payoff =.5606 ($1.934) +.4394 ($0)

Expected payoff = $1.0842

Option value = $1.0842/[1 +.032 (6/12) ]

Option value = $1.0671

Contract value = Option to purchase*Option value

Contract value = 500,000 ($1.0671)

Contract value = $533,600