For j = 1, 2, and t 0, let S j (t) denote the price of
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For j = 1, 2, and t ≥ 0, let Sj(t) denote the price of one share of stock j at time t (in years). Both stocks pay no dividends.
Let π be the current price of a 4-year European exchange option that provides the right to obtain S2(0)/S1(0) shares of stock 1 in exchange for one share of stock 2. The continuously compounded risk-free interest rate is 15%. The volatility of stock 1 is 20%.
The volatility of stock 2 is 10%.
The correlation between the continuously compounded returns on the two stocks is 0.4.
Calculate the ratio π/S2(0).
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