Calculate the price explicitly using a binomial tree

Reference no: EM132208235

Question - One-Step and Two-Step Binomial Trees for Option Pricing

Shares in XYZ Corporation sell today for $20. The risk-free rate is 3% (continuously compounded). In the next six months, XYZ shares will either increase in price by 30%, or decrease in price by 40%. In the following six months, XYZ shares will again either increase in price by 30%, or decrease in price by 40%. XYZ pays no dividends.

a. What is the price of a European call with strike price $19 and expiration in 1 year? Calculate the price explicitly using a binomial tree and the dynamic hedging/replicating method.

b. What is the price of a European put with strike price $19 and expiration in 1 year? Calculate the price explicitly using a binomial tree and the dynamic hedging/replicating method, and verify that put-call parity holds, together with your solution for (a).

Reference no: EM132208235

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