6) Consider a binomial tree model for the stock price St. Let S0 = 70 and...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
6) Consider a binomial tree model for the stock price St. Let S0 = 70 and let the price rise by 11% or fall by 6% each month for the next three months. Assume also that the risk-free rate is 5.5% per annum continuously compounded. (i) State the conditions under which the market is arbitrage free. (2 marks) (ii) Calculate the price at time t = (0 of a European call option on this stock, which expires in three months and is struck at-the-money (i.e. strike price K = 70). (4 marks) A special option, called a knock-out barrier option, goes out of existence (i.e. expires without any payoff or value) if the underlying asset reaches a pre-specified barrier b>0 either from above (down-and-out) or from below (up-and-out). The down-and-out call has the following payoff at time T: !3! max (S, -k:0) if min S, 2b, 0 otherwise Assume this special option is written on the given stock, has the same strike price and maturity as the European call option described in part (ii) and the barrier b is fixed at 50. (iii) Calculate the price of this contract using the binomial tree model and risk neutral valuation. (3 marks) (iv) Determine the price of the down-and-out contract when b = 60, without performing any further calculations. (2 marks) Q7) (10 marks) A non-dividend paying stock currently trades at $75. Every two years the stock price either increases by a multiplicative factor 1.4, or decreases by a multiplicative factor 0.85. The effective risk-free rate is 4% p.a. Calculate the price of an American put option written on the stock with strike price $70 and maturity four years, using a two-period binomial model. 6) Consider a binomial tree model for the stock price St. Let S0 = 70 and let the price rise by 11% or fall by 6% each month for the next three months. Assume also that the risk-free rate is 5.5% per annum continuously compounded. (i) State the conditions under which the market is arbitrage free. (2 marks) (ii) Calculate the price at time t = (0 of a European call option on this stock, which expires in three months and is struck at-the-money (i.e. strike price K = 70). (4 marks) A special option, called a knock-out barrier option, goes out of existence (i.e. expires without any payoff or value) if the underlying asset reaches a pre-specified barrier b>0 either from above (down-and-out) or from below (up-and-out). The down-and-out call has the following payoff at time T: !3! max (S, -k:0) if min S, 2b, 0 otherwise Assume this special option is written on the given stock, has the same strike price and maturity as the European call option described in part (ii) and the barrier b is fixed at 50. (iii) Calculate the price of this contract using the binomial tree model and risk neutral valuation. (3 marks) (iv) Determine the price of the down-and-out contract when b = 60, without performing any further calculations. (2 marks) Q7) (10 marks) A non-dividend paying stock currently trades at $75. Every two years the stock price either increases by a multiplicative factor 1.4, or decreases by a multiplicative factor 0.85. The effective risk-free rate is 4% p.a. Calculate the price of an American put option written on the stock with strike price $70 and maturity four years, using a two-period binomial model.
Expert Answer:
Answer rating: 100% (QA)
6 Solution The options delta cs 30777658 025 The fundamental del... View the full answer
Posted Date:
Students also viewed these finance questions
-
Calculate the price of a three-month European call option on the spot price of silver. The three-month futures price is $12, the strike price is $13, the risk-free rate is 4%, and the volatility of...
-
A stock price is $50. The value of a European call optionwith a strike price of $47.50 and maturity of 100 days is $4.375. The 100-day default-free discount rate is 5 percent, assuming a 360-day...
-
State two conditions under which computing equivalent units will make a material difference to reported inventory amounts.
-
The object provides methods for the creation of Statement objects that will be used to execute Oracle statements in the next step. a. Statement b. Connection c. DriverManager d. Driver
-
Consider the following problem. Maximize Z = 6x1 + x2 + 2x3, Subject to and x1 ¥ 0, x2 ¥ 0, x3 ¥ 0. Let x4, x5, and x6 denote the slack variables for the respective constraints. After you...
-
How does the work required to stretch a spring 2 cm from its natural length compare with that required to stretch it 1 cm from its natural length?
-
List, describe, and provide examples of the various defenses available to a defendant charged with a business crime.
-
The futures price of British pounds is $2.00. Futures contracts are for 10,000 pounds, so a contract is worth $20,000. The margin requirement is $2,000 a contract, and the maintenance market...
-
Sketch a hand written a Enhanced ER diagram for this table and fix the error if there is Message cation D Notification UserNotif Password UserName UserID RoleID User D Phone User # Role securityID...
-
Greyon Inc. operates an active business. Financial statements for the year ended December 31, 2021 report a net income before taxes of $300,000. The following additional information is provided: 1....
-
You, along with about 120 other professionals, are a full time employee of InVentis Ltd (an English limited liability company) providing business consultancy services to creative industries, working...
-
The inverse of \(A \Rightarrow B\) is the implication \(eg A \Rightarrow eg B\). State the inverse of the Pythagorean Theorem. Is it true?
-
A company buys a costly item of electronic equipment that it expects will have a useful life of eight years, and it depreciates the asset over that period. By the end of the fourth year, the item of...
-
Describe how the Markov models of Section 15.4 might be combined with the more symbolic approach to understanding language of Section 15.115.3. Describe how the stochastic models could be combined...
-
How is corporate liability different from liability under respondeat superior?
-
Which is the contrapositive of the implication, "If the car has gas, then it will run"? (a) If the car has no gas, then it will not run. (b) If the car will not run, then it has no gas.
-
This week, we are continuing our focus on the Romantic Period (1820-1900) Music History. I have included a link with the "Top Ten Composers" of the Romantic Period, (and other material you need for...
-
Suppose the market is semistrong form efficient. Can you expect to earn excess returns if you make trades based on? a. Your brokers information about record earnings for a stock? b. Rumors about a...
-
The following are summaries of the cash book and bank accounts of J. Duncan who does not keep his books using the double entry system. You are required to: (a) Calculate the value of J. Duncan's...
-
Read the following and answer the questions below. On 31 December 2015 the bank column of C. Tench's cash book showed a debit balance of 1,500. The monthly bank statement written up to 31 December...
-
The bank columns in the cash book for June 2016 and the bank statement for that month for D. Hogan are as follows: You are required to: () Write the cash book up to date to take the above into...
Study smarter with the SolutionInn App