Question
Question 3: Two-period Binomial Pricing Model [10 Marks] Ms. Jeff, newly recruited staff member of your team at Royal Investments Inc.comes and seeks your
Question 3: Two-period Binomial Pricing Model [10 Marks] Ms. Jeff, newly recruited staff member of your team at Royal Investments Inc.comes and seeks your help on option pricing using the Binomial Tree method. She provides you with the following information: the current market price of stock is $110.00, its annualized return volatility is 0.3810, the annually compounded risk-free rate is 0.0582, the option is a European option with an exercise price of $108 and a time to maturity of 125 days. Jeff would like you to use a two-step binomial tree to show her the following: (1) The periodic risk-free rate (a), the up factor (u), the down factor (d), and the probability of price increase (p). [3 Marks] (2) Construct trees by estimating stock prices, call option prices and hedge ratios for each node of the trees using a two-period binomial pricing model. [4 Marks] (3) Also estimate put option prices and its hedge ratios for each node of the trees using a two-period binomial pricing model. [3 Marks]
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