Financial Risk Management

Over the coming year, Ragwort’s stock price might drop from $100 to $50, or it might rise to $200. The one-year interest rate is 10%. What is the delta of a one-year call option on Ragwort stock with an exercise price of $100? Use the replicating-portfolio method to value this call. In a risk-neutral world, what is the probability that Ragwort stock will rise in price? Use the risk-neutral method to check your valuation of the Ragwort option. If someone told you that, in reality, there is a 60% chance that Ragwort’s stock price will rise to $200, would you change your view about the value of the option? Explain.