# Question

Consider the Level 3 outperformance option with a multiplier, discussed in Section 16.2. This can be valued binomially using the single state variable SLevel 3/SS&P, and multiplying the resulting value by SS&P.

a. Compute the value of this option if it were European, assuming the Level 3 stock price is $100, the S&P index is 1300, and the volatilities and dividend yields are 25% and 0 for the Level 3 and 16% and 1.8% for the S&P. The Level 3-S&P correlation is 0.4 and the option has 4 years to expiration.

b. Repeat the valuation assuming the option is American.

c. In the absence of a multiplier, would you expect the option ever to be earlyexercised? Under what circumstances does early exercise occur with the multiplier?

a. Compute the value of this option if it were European, assuming the Level 3 stock price is $100, the S&P index is 1300, and the volatilities and dividend yields are 25% and 0 for the Level 3 and 16% and 1.8% for the S&P. The Level 3-S&P correlation is 0.4 and the option has 4 years to expiration.

b. Repeat the valuation assuming the option is American.

c. In the absence of a multiplier, would you expect the option ever to be earlyexercised? Under what circumstances does early exercise occur with the multiplier?

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