Suppose that S = $100, = 30%, r = 6%, t = 1, and =

Question:

Suppose that S = $100, σ = 30%, r = 6%, t = 1, and δ = 0. XYZ writes a European put option on one share with strike price K = $90.

a. Construct a two-period binomial tree for the stock and price the put. Compute the replicating portfolio at each node.

b. If the firm were synthetically creating the put (i.e., trading to obtain the same cash flows as if it issued the put), what transactions would it undertake?

c. Consider the bank that buys the put. What transactions does it undertake to hedge the transaction?

d. Why might a firm prefer to issue the put warrant instead of borrowing and repurchasing shares?

Strike Price
In finance, the strike price of an option is the fixed price at which the owner of the option can buy, or sell, the underlying security or commodity. Portfolio
A portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non-publicly...