Let S1(t) and S2(t) denote the prices of two dependent stocks. Assume that the stock prices follow a log-normal distribution. Further assume that the correlation between In S1 and In S2 is p= -0.3 and that S1(0) = 100, S2(0) = 100, r=0.06, sigma1 = 0.4 and sigma2 = 0.2. Neither stock pays dividends. Use risk-neutral valuation to determine the price at time 0 of a derivative which pays the following at time 1:

a) S1 (1) * S2 (1)



b) 1000* S 1(1) / S2(1)

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ANSWER To determine the price at time 0 of a derivative that pays the given cash flows at time 1 we ... View the full answer