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Assignment 4 - IFM

This document provides 5 practice problems related to option pricing using binomial trees. Each problem provides inputs such as the current stock price, possible future stock prices, risk free rates, time periods, and option payoff structures. The student is asked to calculate option prices based on these inputs, showing their work. The problems cover calls, puts, strangles, and butterfly spreads on stocks over time periods ranging from 1 month to 2 years. Sample answers are provided for each problem.

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Kim Bình
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100 views3 pages

Assignment 4 - IFM

This document provides 5 practice problems related to option pricing using binomial trees. Each problem provides inputs such as the current stock price, possible future stock prices, risk free rates, time periods, and option payoff structures. The student is asked to calculate option prices based on these inputs, showing their work. The problems cover calls, puts, strangles, and butterfly spreads on stocks over time periods ranging from 1 month to 2 years. Sample answers are provided for each problem.

Uploaded by

Kim Bình
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Assignment 4

1. For a nondividend-paying stock, you are given:


(i) The current stock price is 50.
(ii) At the end of 1 month, the stock price will be either 52 or 48.
(iii) The continuously compounded risk-free interest rate is 2%.
Consider a 1-month 51-strike European call on the stock. Calculate the time-0 price of the
call? (take 2 digits after the decimal point)
Answer: 0.52

2. For a nondividend-paying stock, you are given:


(i) The current stock price is 100.
(ii) At the end of 1 month, the stock price will be either 105 or 95.
(iii) The continuously compounded risk-free interest rate is 3%.
Calculate the risk-neutral probability of an increase in stock price in 1 year? (take 4 digits
after the decimal point)
Answer: 0.8045

3. For a strangle on a nondividend-paying stock whose current price is 60, you are given:
(i) The strangle can only be exercised at the end of 1 year.
(ii) At the end of 1 year, the stock price will be either 75 or 45.
(iii) The continuously compounded risk-free interest rate is 8%.
(iv) Let S(1) be the stock price at the end of 1 year. The payoff from the strangle is as
follows:
Range of S(1) Payoff
S(1)  60 60 – S(1)
60 < S(1) < 70 0
S(1)  70 S(1) - 70
Calculate the price of the strangle? (take 5 digits after the decimal point)
Answer: 7.69349

4. You are to price a 2-year at-the-money European put option on a stock with a binomial
model. You are given:
(i) The current stock price is 100.
(ii) The stock pays dividends continuously at a rate proportional to its price. The dividend
yield is 3%.
(iii) The binomial tree consists of 2 time steps of 1 year.
(iv) In each time step, the stock price either moves up by a proportional amount of 25% or
moves down by a proportional amount of 25%.
(v) The continuously compounded risk-free interest rate is 3%.
Calculate the current price of the put? (take 2 digits after the decimal point)
Answer: 13.24

5. You are to price a butterfly spread on a stock with a forward binomial tree. You are
given:
(i) The butterfly spread can only be exercised at the end of 6 months.
(ii) The stock currently sells for 100. The stock’s volatility is 30%.
(iii) The stock pays dividends continuously at a rate proportional to its price. The dividend
yield is 3%.
(iv) The continuously compounded risk-free interest rate is 5%.
(v) Let S(0.5) be the stock price at the end of 6 months. The payoff from the butterfly
spread is as follows:
Range of S(0.5) Payoff
S(0.5) < 80 0
80  S(0.5) < 100 S(0.5) – 80
100  S(0.5) < 120 120 – S(0.5)
S(0.5)  120 0
(vi) The binomial tree consist of three time steps of 2 months.
Calculate the current price of the butterfly spread? (take 4 digits after the decimal point)
Answer: 5.6160

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