Question
The possible movement in share price over the next 12 months is depicted in the 4-step Binomial tree shown below. Key details are: the proportional
The possible movement in share price over the next 12 months is depicted in the 4-step Binomial tree shown below.
Key details are:
the proportional up and down movements on each branch of the tree are u = 1.1912 and d = 0.8395 respectively
the riskfree interest rate is 4% pa continuously compounded
Let ST denote the share value one year from now (far right side of the Binomial tree).
A strange derivative security is based on this share. It has a payoff = sqrt(ST).
That is, if you buy this derivative today, one year from now you receive a payoff equal to the square root of whatever the share price is.
Required:
Using the 4-step Binomial tree, calculate the fair value of this derivative today.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started