Amazonia provides a range of online shopping and web services and is listed on the stock exchange. It is currently the subject of a takeover offer that is expected to take 9 months to be resolved. The current stock price is 55 dollars. If the takeover offer is successful, shareholders will receive 70 dollars per share in 9 months from now. If the takeover offer is unsuccessful, the stock price is expected to fall to 35 dollars in 9 months from now. A call option written on this stock has an exercise price of 50 dollars and will mature in 9 months. The risk-free interest rate is 3.0 percent per annum. 1. There is a combination of a stock and a bond that replicates the payoffs of the call option under the two possible future outcomes. Calculate the cost of buying the correct number of shares in the replicating portfolio today?
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Step 1
This can be done by comparing the payoffs of the call option under the two possible future outcomes. If the takeover offer is successful, the call option will be worth 70 - 50 = 20 dollars. If the takeover offer is unsuccessful, the call option will be worthless Show more…
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