Hi I need help with the following problem: Suppose you are attempting to value a

Question

Hi I need help with the following problem:

Suppose you are attempting to value a 1-year maturity option on a stock with volatility (i.e.,annualized standard deviation) of 0.30.

What would be the appropriate values for u and d if your binomial model is set up using: (Do not round intermediate calculations. Round your answers to 4 decimal places.)

Thank you.

Suppose you are attempting to value a 1-year maturity option on a stock with volatility (i.e.,annualized standard deviation) of 0.30.

8= exp(

Explanation / Answer

Answer:

As we have been already given the model formulas for the binomial calculation values for u and d

Sigma value already given 0.30

Putting the values in the equation

Here I have assumed that sigma in the formula used is annualized. if taken according to the month time . use this formula to convert,

Sigma (monthly)= Sigma annual / sqrt(12), sigma (quarterly) = sigma annual/ sqrt(4)

Subperiods Delta T = T/n u = exp(sigma(squareroot(delta T)) d = exp(-sigma(squareroot(delta T)) 1 1 1.349858808 0.740818221 4 0.25 1.161834243 0.860707976 12 0.0833 1.090444289 0.917057396

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