You own a call option on Pester Me stock that expires in one year. The exercise price is $22.50. The current price of the stock is $26.40 and the risk-free rate of return is 4 percent. Assume that the option will finish in the money. What is the value of the call option?
A) -$4.77
B) -$3.90
C) $0
D) $3.90
E) $4.77

Question

Quizplus · Accepted Answer

The value of a call option is the current stock price minus the present value of the exercise price. Here, the intrinsic value is $26.40 - $22.50 = $3.90. However, since the option will finish in the money, we must also consider the time value. The present value of the exercise price is $22.50 / (1 + 0.04) = $21.63. Thus, the option value is $26.40 - $21.63 = $4.77.

You Own a Call Option on Pester Me Stock That