Reference no: EM132979930
Question - A one-step binomial tree is used to model the impact of an important announcement on the stock price of Company XYZ. There is a 50% chance that the announcement will be positive for the company. The Company does not pay dividends.
Current stock price = K20
Stock price after good news = K30
Stock price after bad news = K15
Time period = 3 months
Risk-free rate (continuous compounding) = 5 %
a) Calculate the price of a 3-month call option on the Company stock with strike price equal to K22.
b) Suppose you are a market-maker in the Luse Index forward contracts. The Luse Index spot price is K1, 100 and the annual risk free rate is 5%.
i. Calculate the forward price for delivery in 9 months.
ii. If the actual forward price is K1,122, how can you take advantage on this situation?
iii. What are the problems that you will face in taking advantage of the situation?
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