Assume the following parameter values: S=100, u=2, d=.5, R=1.25. 1. Construct a binomial tree showing the possible stock price movements over two periods. Use the
Assume the following parameter values: S=100, u=2, d=.5, R=1.25.
1. Construct a binomial tree showing the possible stock price movements over two periods. Use the tree to compute the fair values for:
a. a two-period 100 strike call option;
b. a two-period 100 strike European put option.
2. Show that the prices in Q.1 obey put-call parity. Hint: Remember that for discounting cash flows in the tree, (1 + the riskless interest rate) for two periods = R2 .
3. Suppose the call was priced at its fair value that you calculated in Q. 1, and the put had the same price as the call. What trade should you do to produce a riskless arbitrage profit?
4. What is the fair value for a two-period 100 strike American put?
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Authors: Misook Yu CFP
1st Edition
1732024510, 978-1732024519
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