What is the risk neutral probability distribution for stock

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Reference no: EM132753336

Problem 1: A stock may go up or down for each of the next 3 periods (t=1, 2, 3) by 10%. At period 3 it will pay Min[10, Max(S(t)-Min(S(t)) for t=0,1,2,3. Today's price is 45 for the stock and the risk free rate is 5%. What is the value of this option?

Problem 2: What is the risk neutral probability distribution for the stock in the Black-Scholes model, including the parameters?

Problem 3: Take the parameters of the option in question 2. However, change it to be a standard call with a strike price of 45. Now, show by iterated application of the one period binomial formula, the three period formula (using Pascal's triangle, etc), and the binomial distribution formula, that all three methods give the same option value.

Reference no: EM132753336

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