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CA Final · Advanced Financial Management · Derivatives Analysis and Valuation

Shares of Kaveri Auto trade at ₹100. Over the next period the price will move either to ₹120 or to ₹80. A one-period European call has a strike of ₹100, and the risk-free rate is 5% for the period. Using the binomial model, what is the call value today?

The call is worth about ₹11.90. A replicating portfolio of 0.5 share financed by borrowing ₹38.10 matches the payoffs of 20 and 0. Equivalently, the risk-neutral probability of 0.625 applied to the payoff of 20 and discounted at 5% gives the same value.

  1. A₹11.90Correct
  2. B₹12.50
  3. C₹9.52
  4. D₹10.00

Explanation

Payoffs are 20 and 0. Delta = 20/40 = 0.5. Borrowing = 0.5×80/1.05 = 38.095. Call = 50 − 38.095 = ₹11.905. Check with risk-neutral p = (105−80)/40 = 0.625, so C = 0.625×20/1.05 = 11.905. ₹12.50 omits discounting, and ₹9.52 wrongly uses p = 0.5.

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