A broker writes an American call option with strike E = 95 and expiry date T...

 

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A broker writes an American call option with strike E = 95 and expiry date T = 3 years. The risk-free interest rate is r = 0.05 and the initial stock price So 100. (a) Compute the fair price of the option using a 3-level tree model with dt = 1, u = 1.2 and d = 0.8. (b) Compute at each node the payoff from the early exercise of the option and confirm that it is less than the value of the option calculated recursively. (c) Consider the price path up-down-down and describe the cash flow of the corresponding delta-hedging procedure. A broker writes an American call option with strike E = 95 and expiry date T = 3 years. The risk-free interest rate is r = 0.05 and the initial stock price So 100. (a) Compute the fair price of the option using a 3-level tree model with dt = 1, u = 1.2 and d = 0.8. (b) Compute at each node the payoff from the early exercise of the option and confirm that it is less than the value of the option calculated recursively. (c) Consider the price path up-down-down and describe the cash flow of the corresponding delta-hedging procedure.

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a The stock price at time t0 is S0100 The stock price at time t1 is S11S0112 The stock prices at tim... View the full answer