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We obtained the binomial option pricing formula by hedging a short position in the call option with

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We obtained the binomial option pricing formula by hedging a short position in the call option with a long position in stock. An alternative way to do this is to combine the stock and a risk-free bond to replicate the call option. Construct a one-period binomial option pricing model in which the stock and a risk-free bond are used to replicate a European call option. Then show that the option pricing formula is the same as the one developed in the text. Hint: Hold ns shares of stock and issue B dollars of bonds paying r percent so that the value in both outcomes matches precisely the value of the option. Then solve for ns and B and substitute back into the formula for the value of the hedge portfolio today to obtain the formula for C?
Portfolio
A portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non-publicly...
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Let B be the amount issued in bonds Then the initial ...View the full answer


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Introduction To Derivatives And Risk Management

Introduction To Derivatives And Risk Management

ISBN: 9781305104969

10th Edition

Authors: Don M. Chance, Robert Brooks

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A call option is a type of financial contract that gives the holder the right, but not the obligation, to buy an underlying asset (such as a stock, commodity, or currency) at a specified price (called the strike price) within a specified period of time. When an investor purchases a call option, they are essentially betting that the price of the underlying asset will rise above the strike price before the option\'s expiration date. If the price of the asset does rise above the strike price, the investor can exercise the option by buying the asset at the strike price and then selling it at the higher market price, thereby earning a profit. Call options are often used as a speculative investment strategy, as they allow investors to potentially profit from the upward movement of an asset without having to actually own the asset itself. They are also commonly used as a hedging tool to protect against potential losses in a portfolio.

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