Question 4 [replicating strategy for exotic derivative] A stock is currently priced at $20. The volatility of the stock is 40% pa and the riskfree rate of interest is 4% pa with cntinuous compounding. We model the possible movement of stock price over the next 6 months using a one-step Binomial tree. This means that u=1.3269 and d= 0.7536 Let ST denote the stock price 6 months from now. Define a new derivative security which has a payoff equal to (ST)2. That is, if you buy this derivative security today, in 6 months' time, you will receive a cash payment equal to the square of stock price at the point. How much will this derivative security sell for in the market today? Hint: don't be distracted by the unusual nature of this derivative. It is not an option. It doesn't even have a strike price. Nevertheless, you can still use either of the methods from Lecture 9 to price the derivative (delta-hedging will be easier; try both methods if you are keen). Question 4 [replicating strategy for exotic derivative] A stock is currently priced at $20. The volatility of the stock is 40% pa and the riskfree rate of interest is 4% pa with cntinuous compounding. We model the possible movement of stock price over the next 6 months using a one-step Binomial tree. This means that u=1.3269 and d= 0.7536 Let ST denote the stock price 6 months from now. Define a new derivative security which has a payoff equal to (ST)2. That is, if you buy this derivative security today, in 6 months' time, you will receive a cash payment equal to the square of stock price at the point. How much will this derivative security sell for in the market today? Hint: don't be distracted by the unusual nature of this derivative. It is not an option. It doesn't even have a strike price. Nevertheless, you can still use either of the methods from Lecture 9 to price the derivative (delta-hedging will be easier; try both methods if you are keen)