A stock with a current price of 100 in the next period can go up by...

 

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A stock with a current price of £100 in the next period can go up by 10% or go down by 10%. Suppose the interest rate is 5%. Using the binomial option pricing technique, construct an alternative replicating portfolio that entails borrowing to finance a long position in the stock and from this portfolio find the price of a call option on the stock with a maturity of one period and exercise price of £100. Explain carefully your rationale and show all your calculations. A stock with a current price of £100 in the next period can go up by 10% or go down by 10%. Suppose the interest rate is 5%. Using the binomial option pricing technique, construct an alternative replicating portfolio that entails borrowing to finance a long position in the stock and from this portfolio find the price of a call option on the stock with a maturity of one period and exercise price of £100. Explain carefully your rationale and show all your calculations.

Answer rating: 100% (QA)

SOLUTION To construct an alternative replicating portfolio we need to determine the number of shares to buy and the amount to borrow Well assume that the stock pays no dividends Lets define the follow... View the full answer