Multiple Choice
Two stocks A and B both have a current price of $100 and are identical in every way except that the risk-neutral probability of default of A in three months is 10%, and that of B is zero. Assume a CRR-style jump-to-default model in which the volatility of both stocks is 30%. The risk-free rate is 2%. Consider the price of three-month at-the-money call options on these two stocks in a one-period jump-to-default tree model. Which of the following statements is valid?
A) The call option on A is worth less than the call option on B.
B) The call option on A is worth the same as the call option on B.
C) The call option on A is worth more than the call option on B.
D) There is insufficient information to determine which option is worth more.
Correct Answer:
Verified
Correct Answer:
Verified
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