The S&P-500 ETF is trading at 1,260 today. In one year the price will either grow by
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Question:
The S&P-500 ETF is trading at 1,260 today. In one year the price will either grow by 15 per cent if there is an expansion, or fall by 15 per cent if there is a recession. There are no dividends. A one-year zero coupon bond purchased today has a 1 per cent interest rate.
a. What is the price of a European call option with strike price 1,100? 1,260? Describe the portfolio which would exactly replicate the first of these securities.
b. What is the price of a quasi-American put with a strike price of 1,260?
Assume that every six-months the S&P-500 ETF either goes up by 10 per cent or down by 10 per cent and that the six-month interest rate is 1 per cent (Note that the annual standard deviation of the underlying is 0.12=14.1% , which is nearly the same as before).
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