II. Binomial option pricing formula Let K = 60, s 60, u 1.45, d = 0.65, r 5% and
ID: 2797067 • Letter: I
Question
II. Binomial option pricing formula Let K = 60, s 60, u 1.45, d = 0.65, r 5% and that you are three years from expiration. Base your answers on a 3-step tree 8. How many up moves a are required to ensure that a call option finishes in the money: (a 9. What is the risk neutral probability p: (a) 0.1; (b) 0.2; (c) 0.5; (d) 0.8; 10. What is e-T: (a) 1.45; b) 1.05; (c) 0.95; (d) 0.86; The binomial option pricing formula is given by 11. The value of the term 012;3.2) is: (a) 0.38; (b) 0.63; (c) 0.77; (d) 0.85; 12. The value of the term 9(3; 3,p) is: (a) 0.61; (b) 0.82 (c) 0.13; (d) 0.50; 13. The value of the term o(23,p) [Sud-Kl is: (a) 8.28; (b) 6.42; (c) 25.37; (d) 18.34; 14. The value of the term 5(3;3,p)[Su3d - K]: (a) 5.94; (b) 15.51; (c) 2.91; (d) 12.25; 15. The binomial value of the call is: (a) 10.32; (b) 18.45; (c) 20.47; (d) 13.35,;Explanation / Answer
(8) How many up movements are required for call option to be in the money
Answer: 1
Since Option is at the money. That is Spot is equal to Strike. Even a single up movement will lead option to be in the money
(9) Risk neutral Probability (p) = (1+rf - d) / (u-d) = (1.05-0.65) / (1.45-0.65) = 0.50
(10) e-rt = e-0.05*3 = 0.86