You must use three components to form a portfolio and replicate the terminal payoff of the above derivative. The first component must involve taking a long position on two stocks of the company.

In addition, you are provided with the following information:

• Current stock price of the company = $10 per share
• Annual risk-free rate of interest = 6% p.a. compounded continuously
• Stock volatility (σ) = 20% per year

Required: 

Calculate the fair price (estimated at time t=0) of the derivative. 

State your answer in two decimals (e.g., $5.12). You may want to show your calculations, or briefly describe how you arrive at the final answer, so that partial marks can be allocated for incorrect answer. Also, the "BlackScholes.xlsx" calculator  may be useful.

Answer rating: 100% (QA)

To calculate the fair price of the derivative we can use the BlackScholes formula which is given by ... View the full answer