Intrinsic value

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5.   Assume that one year from now, ABC company stock will have a price of $48 (30% chance), $46 (40% chance) or $24 (30% chance).  The current price of ABC company stock is $40.  Consider an option with an exercise price of $38.

5a. Compute the intrinsic value of the option (i.e., the value of the option if it had to be exercised currently).  Show your computations?  (5 points)

Intrinsic Value: $6.2  Computations:   

5b. Compute the market value of the option if it allows the share to be purchased one year from now (note that in this simple example, you don’t need the Black-Scholes formula).  Show your computations (5 points)

Market Value: $2  Computations:  

5c. Assume that due to rapid market changes the future price of ABC becomes “more volatile” – for example, the high prices become higher and the low prices become lower, while the expected future value remains the same.  Would you expect that the market value of the option would increase, decrease, or remain the same.  Briefly (one sentence should suffice) explain.  Note that no math is necessary to answer this part of the question.  (5 points)

                               The market value of the option will (Choose one)       Increase                                         Decrease                                 Remain the same  
Explanation: