Suppose also that the current risk-free rate is 2 pa and


A friend of your believes that BlackBerry stock is now overvalued. As a result, she expects that their stock price, now at $14 per share, will not go up any further. She is prepared to back up her conviction by offering you the following bet. If in exactly one year from now Blackberry stock price is higher than $14/share, she will give you two hundred times the amount of the difference (e.g., suppose the price in one year is $16 per share, you will get $400). On the other hand, if the price in one year ends up below $14/share, you will have to give her two hundred times the amount of the difference (e.g., suppose the price in one year is $11 per share, you will have to give her $600). Suppose that the expected return on Blackberry stock is 7% p.a. Suppose also that the current risk-free rate is 2% p.a. and Blackberry does not plan to pay dividends in the next year. What is the value of this bet to you? [Hint: Write out the payoff of the bet. What does the payoff look like?]

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Financial Management: Suppose also that the current risk-free rate is 2 pa and
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