Use a 2 step binomial tree to value a new exotic derivative. Draw the tree and label the stock prices and derivative values at each node.

The option expires in 6 months. The interest rate is 10% annually continuously compounded. The Strike Price (K) is 100.

The spot price is at 100. U= 1.2 and D= 0.8 for each quarterly period. The payoff of this derivative is (ST/K). By this I mean that the payoff is the price of the underlying stock divided by the Strike Price.

a) Explain the difference between Value at Risk at q% level and expected shortfall at q% level?

b) Does Gamma increase or decrease on at the money options as they approach expiration?