1. A company currently pays a dividend of $2 per share (D0 = $2). It is estimated that the company's dividend will grow at a rate of 20% per year for the next 2 years, and at a constant rate of 7% thereafter. The company's stock has a beta of 1.2, the risk-free rate is 7.5%, and the market risk premium is 4%. What is your estimate of the stock's current price?
2. Consider a stock with a current price of $27. Suppose that over the next 6 months the stock price will either go up by a factor of 1.41 or down by a factor of 0.71. Consider a call option on the stock with a strike price of $25 that expires in 6 months. The risk-free rat is 6%.
A. Using the binomial model, what are the ending values of the stock price? What are the payoffs of the call option?
B. Suppose you write one call option and buy N shares of stock. How many shares must you buy to create a portfolio with a riskless payoff (i.e., a hedge portfolio)? What is the payoff of the portfolio?
C. What is the value of the call option?
D. What is the value of the put option on the stock with the same maturity and the same strike price?