A non-dividend paying stock is currently trading at 35. Over each of the next two 3-month...

 

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A non-dividend paying stock is currently trading at 35. Over each of the next two 3-month periods it is expected to either go up by 10% or down by 10%. The risk-free interest rate is 5% per annum with continuous compounding. Suppose there is a 6-month European put option with a strike price of 34. Answer the following questions (show all the details of your calculations and present your results with four decimal places) a) Draw a two-period binomial tree for the underlying asset. b) Calculate the price of the option today. (5 marks) (10 marks) c) Work forward on the tree and show that there is a self-financing trading strategy that replicates the value of the European put option at each node in the tree. (25 marks) d) Suppose the option is American. Calculate its price today. (10 marks) A non-dividend paying stock is currently trading at 35. Over each of the next two 3-month periods it is expected to either go up by 10% or down by 10%. The risk-free interest rate is 5% per annum with continuous compounding. Suppose there is a 6-month European put option with a strike price of 34. Answer the following questions (show all the details of your calculations and present your results with four decimal places) a) Draw a two-period binomial tree for the underlying asset. b) Calculate the price of the option today. (5 marks) (10 marks) c) Work forward on the tree and show that there is a self-financing trading strategy that replicates the value of the European put option at each node in the tree. (25 marks) d) Suppose the option is American. Calculate its price today. (10 marks)

Answer rating: 100% (QA)

a Twoperiod binomial tree Period 1 Period 2 35 u11 385 35 42 315 d09 2835 b European put opt... View the full answer