A six-month American call option on ALCO stock has an exercise price of $50. The currentALCO stock price is $50, the risk free rate is 4% p.a. (continuously compounded) for allmaturities and the volatility of the ALCO stock price is 30% p.a. ALCO is expected to pay adividend of $1.00 in three months’ time.
Required
(a) Use a three-period binomial model to value the six-month American call option onALCO stock. Remember to show detailed calculations of the option value at each node.
(b) How valuable is the right of early exercise?