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Current Stock price S(0) is $60; risk-free rate is 3% (simple rate). There are two possible outcome in one year, stock price might go up
Current Stock price S(0) is $60; risk-free rate is 3% (simple rate). There are two possible outcome in one year, stock price might go up 40% (to $84 ) or go down 40% (to $36 ). Consider both a call and a put with the same strike price of $60 and one year to maturity. a. You estimate that the probability of stock price to go up is 90% and probability to go down is about 10%. Compute the price of call and put and also expected returns on the stock, call, put and a straddle (combination of a call and put with same strike of \$60) using the binomial tree model. (6) b. However you are not sure about your estimates of the probabilities and decide to check out your results under different scenarios. You write down the following scenarios (P is the probability of stock price to go up to $84 ): (18)
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