Scribd
Upload
21 views

Week03 Questions

The document contains two example questions. The first asks to price a one period binomial option using a riskless hedge. The second asks to model a two period binomial option pricing model by finding stock prices, call prices, hedge ratios and showing the riskless hedge works.

Uploaded by

Stephen Bahadar
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
21 views

Week03 Questions

The document contains two example questions. The first asks to price a one period binomial option using a riskless hedge. The second asks to model a two period binomial option pricing model by finding stock prices, call prices, hedge ratios and showing the riskless hedge works.

Uploaded by

Stephen Bahadar
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 1

Week 03 Workshop Questions

Example1: One-Period Binomial Option Pricing Model

Consider a stock currently priced at $100. One period later it can go up to $125, an increase of 25
percent, or down to $80, a decrease of 20 percent. Assume a call option with an exercise price of
$100. The risk-free rate is 7 percent. What amount of riskless return can be earned using riskless
hedge assuming that the market price of call option is:

a) equals to the estimated current fair price of the call option (Cm = C0)
b) $15
c) $13

Also assume that T = n, number of call options traded equals to 1000, and 1 call option contract gives
right to buy or sell 1 share of underlying stock.

Chapter 4: Question 8 – Two-Period Binomial Option Pricing Model

Consider a two-period, two-state world. Let the current stock price be 45 and the risk-free rate be 5
percent. Each period the stock price can go either up by 10 percent or down by 10 percent. A call
option expiring at the end of the second period has an exercise price of 40.

a) Find the stock price sequence.


b) Determine the possible prices of the call at expiration.
c) Find the possible prices of the call at the end of the first period.
d) What is the current price of the call?
e) What is the initial hedge ratio?
f) What are the two possible hedge ratios at the end of the first period?
g) Construct an example showing that the hedge works. Make sure the example illustrates how the
hedge portfolio earns the risk-free rate over both periods.
h) What would an investor do if the call were overpriced? If it were underpriced?

Assume that T = n, number of call options traded equals to 1000, and 1 call option contract gives
right to buy or sell 1 share of underlying stock.

You might also like