Calculate the price of a two year 106 strike european put

Assignment Help Financial Management

Reference no: EM131243676

Binomial tree: random interest rates I

Consider the two-step binomial tree in Chapter 8 Question 1. However, now suppose that if the stock is at 120, then the annually compounded interest rate from time T = 1 to T = 2 is 5%, not 10%.

(a) Write down the value of the money market account Mm at all states of the tree. Does the joint tree for (S_m, M_m) recombine?

(b) By using the martingale condition for S_m/M_m, find the risk-neutral probabilities with respect to the money market numeraire Mm at each node of the tree.

(d) Use (c) and an appropriate martingale condition to prove that the risk-neutral probability, with respect to the numeraire Z(m, 2), of the stock having value 120 at T = 1 is 44/65. Hence show that the risk-neutral probabilities of this state, with respect to the money market account and the ZCB with maturity T = 2, differ by 2/195. Do you want to revisit your comments in Question 1(b)?

Question 1

Binomial tree: European and American puts Consider a two-step binomial tree, where a stock that pays no dividends has current price 100, and at each time step can increase by 20% or decrease by 10%. The possible values at time T = 2 are thus 144, 108 and 81. The annually compounded interest rate is 10%.

(a) Calculate the price of a two-year 106-strike European put using (i) a replication argument and (ii) risk-neutral expectation.

(b) Calculate the price of a two-year 106-strike American put using replication, and hence verify that the American put has price strictly greater than the European.

Reference no: EM131243676

Questions Cloud

What rate of return would be realized : Baxter purchased 100 shares of Sam, Inc. common stock for $25 per share one year ago. During the year, Sam, Inc paid cash dividends of $2 per share. The stock is currently selling for $30. If Baxter sells all his shares today, what rate of return..

Potentially acceptable vpn solution : State the general characteristics of one solution that meets the security and user requirements. Name the vendor(s) and VPN services. It is generally about 3 sentences.

Draw a graph that displays the distribution of the distance : ECON 1030 - BUSINESS STATISTICS 1 PROJECT - Discuss whether the signs are what you are expecting and explain your reasoning and what other factors would have influenced the price of homes? Provide a couple possible examples and indicate their predi..

How level of employee is involved in implementing the change : Describe how each level of employee is involved in implementing the change. Describe any changes in organizational structure or size that may result from the change in strategy.

Calculate the price of a two year 106 strike european put : Calculate the price of a two-year 106-strike European put using (i) a replication argument and (ii) risk-neutral expectation.

Prompting an appropriate message : Write a program in Java which should accept the following information from the user after prompting an appropriate message:

How does the self-fulfilling prophesy shape adjustment : The operational definition of maturity says that maturity is characterized by the ability to delay gratification and to plan for the future. In contrast immature behavior is characterized by the need for immediate gratification and an inability to..

Social media policies for sharing information : What challenges do corporations face with regards to social media? Do companies have social media policies for sharing information? Provide an example.

Find the price of a two year 120 strike european call option : Find the price of a two-year 120-strike European call option. - What is the risk-neutral distribution of the random variable Z (1, 2) with respect to the numeraire that is the ZCB with maturity T = 2?

User Account

All Pages