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PLZ PLZ HELP Consider an institution that has just sold to a client an at-the-money American put option with a 6month maturity. The underlying is
PLZ PLZ HELP
Consider an institution that has just sold to a client an at-the-money American put option with a 6month maturity. The underlying is a non-dividend paying stock priced at $30. Assuming a continuously compounded risk-free rate of 6% p.a. and stock price movements of +/10% each period a) Price the option using a three-period binomial option pricing model. [4 marks] b) Given the pricing model you used in part a), when should the client exercise the option?Why? [2 marks] c) Show how the institution would hedge their exposure to the stock if the stock price fell every period. [5 marks] d) Explain the intuition behind the evolution of the hedging strategy over the life of the hedge. [2 marks] e) Is the price for an otherwise equivalent European put likely to be higher or lower than the price of the American put? Why? [2 marks] Consider an institution that has just sold to a client an at-the-money American put option with a 6month maturity. The underlying is a non-dividend paying stock priced at $30. Assuming a continuously compounded risk-free rate of 6% p.a. and stock price movements of +/10% each period a) Price the option using a three-period binomial option pricing model. [4 marks] b) Given the pricing model you used in part a), when should the client exercise the option?Why? [2 marks] c) Show how the institution would hedge their exposure to the stock if the stock price fell every period. [5 marks] d) Explain the intuition behind the evolution of the hedging strategy over the life of the hedge. [2 marks] e) Is the price for an otherwise equivalent European put likely to be higher or lower than the price of the American put? Why? [2 marks]Step by Step Solution
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