7.1. Using risk-neutral valuation, derive a formula for a derivative that pays cash flows over the next

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7.1. Using risk-neutral valuation, derive a formula for a derivative that pays cash flows over the next two periods. Assume the risk-free rate is 4 percent per period.

The underlying asset, which pays no cash flows unless it is sold, has a market value that is modeled in the adjacent tree diagram.

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The cash flows of the derivative that correspond to the above tree diagram are

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Find the present value of the derivative.

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Financial Markets And Corporate Strategy

ISBN: 9780071157612

2nd Edition

Authors: Mark Grinblatt, Sheridan Titman

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