Assume that a non-dividend-paying stock has an expected return of and a volatility of . An

Question:

Assume that a non-dividend-paying stock has an of Î¼ and a volatility of Ïƒ. An innovative financial institution has just announced that it will trade a derivative that pays off a dollar amount equal to at time T.

The variables S0 and ST denote the values of the stock price at time zero and time T.
a) Describe the payoff from this derivative.
b) Use risk-neutral valuation to calculate the price of the derivative at time zero.

Expected Return
The expected return is the profit or loss an investor anticipates on an investment that has known or anticipated rates of return (RoR). It is calculated by multiplying potential outcomes by the chances of them occurring and then totaling these...