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Question
An FI manager purchases a zero-coupon bond that has two years to maturity. The manager paid $76.95 per $100 for the bond. The current yield on a one-year bond of equal risk is 12 percent, and the one-year rate in one year is expected to be either 16.65 percent or 15.35 percent. Either rate is equally probable.
If the manager buys a one-year option with an exercise price equal to the expected price of the bond in one year, what will be the exercise price of the option?
A. $84.00.
B. $85.99.
C. $86.21.
D. $85.74.
E. $85.96.
Answer
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