• consider the two-state example with the modifications:
• The stock price today is equal to $50.
• In one period it will either go up by $10 or go down by $10.
• The one-period risk-free rate of interest is 6%

Question 1.

Draw a one-period tree with the stock price that starts at 50 and goes to either 60 or 40 (as in class)

Calculate the implied (risk-neutral) probabilities, without looking at the lecture notes.

What is the implied probability of the stock price increasing?

Group of answer choices

65%

35%

25%

0%

Question 2

Suppose there is one change: stock price can actually increase to $90 (instead of 60)

Will it make the implied probability of an increase in price ...

Group of answer choices

smaller

larger

Question 3

Return to the original assumptions that lead to 65% probability in increasing stock price (and 35% decreasing)

Your boss demands that you estimate the price of an exotic option that pays $100 in good economy state and $10 in bad economy state. What is your APPROXIMATE quick answer?

Group of answer choices

about $65

about $50

about $10