Plot the binomial option value against the number of tree

Reference no: EM133632628

Assignment:

Question 1
Consider a non-dividend paying stock with a current stock price is $45, where the volatility of the stock price is 30% per annum and the risk free rate is 5% per annum. Using a binomial tree with a step length of one month, calculate
the following:

u, d, and the risk neutral probability p for the tree.
The value of a European call option on the stock, both with a strike price of 42.50 and a time to maturity of three months.
The value of a European put option and an American put option on the stock, both with a strike price of 42.50 and a time to maturity of three months. Also calculate the time value and the early exercise premium.
Verify that the put call parity holds for the European options.

Question 2
Consider a 6-month European call option on a non-dividend paying stock where the current stock price is $60, the
strike price is $65, the volatility is 35%, and the risk free rate 5% per annum.

Value the option using a 3-step binomial tree.
You may perform this question in Excel. Increase the number of steps in the binomial tree in increments of three (3) steps each time recalculating the value of the option. Stop when you get to 51 steps.
That is:
- use a 3-step binomial tree (step size = 2 months) and calculate the value of the option
- then use a 6-step binomial tree (step size = 1 month) and calculate the value of the option
- then use a 9-step binomial tree (step size = 0.667 of a month) and calculate the value of the option
- then use a 12-step binomial tree (step size = 0.5 of a month) and calculate the value of the option
- and so on until you get to 51 steps

Plot the binomial option value against the number of tree steps. Describe the pattern you observe.
Submit (upload) your Excel workbook along with a word file of your assignment answers

Reference no: EM133632628

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