Scribd
Upload
51 views

Lecture 16 PS

This document provides problems for a lecture on asset markets. It includes: 1) A binomial tree model to price a 2-year European call and put option on a stock trading at £50 that can rise or fall 20% annually over 2 years. It asks to verify put-call parity and determine replicating portfolios. 2) Using Excel to price an American put option on a stock that can rise 20% or fall 10% over 4 periods with a 10% risk-free rate. It asks to determine the optimal exercise policy and price the put under varying stock prices, strike prices, and return probabilities. 3) The student should turn in printouts of their Excel sheets pricing the put option

Uploaded by

Simon Galviz
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
51 views

Lecture 16 PS

This document provides problems for a lecture on asset markets. It includes: 1) A binomial tree model to price a 2-year European call and put option on a stock trading at £50 that can rise or fall 20% annually over 2 years. It asks to verify put-call parity and determine replicating portfolios. 2) Using Excel to price an American put option on a stock that can rise 20% or fall 10% over 4 periods with a 10% risk-free rate. It asks to determine the optimal exercise policy and price the put under varying stock prices, strike prices, and return probabilities. 3) The student should turn in printouts of their Excel sheets pricing the put option

Uploaded by

Simon Galviz
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 2

LSE FM423 Asset Markets

Zachariadis

Problems for Lecture 16

1. KZMM.com’s stock is trading at £50 per share. The stock price will either go up or
go down by 20% in each of the next two years. The annual interest rate is 10%.

(a) Determine the price of a two-year European call option with strike price £45. Do
not calculate the replicating portfolio strategy.
(b) Determine the price of a two-year European put option with strike price £45. Do
not use put-call parity; you will be asked to verify that it holds in part (c). Also,
do not calculate the replicating portfolio strategy; you will be asked to do that in
part (d).
(c) Verify that put-call parity holds (at the initial node as well as at the intermediate
nodes).
(d) What is the replicating portfolio strategy, using the stock and the bond, for the
European put option with strike price £45? Compute the portfolio for every node
of the tree. Assume that the bond has face value equal to £1.

2. In this exercise you are asked to use Excel to price an American put option in a binomial
tree.

(a) Price the put with the following parameters.


• Initial stock price: 100.
• Time to maturity: 4 periods.
• Stock returns: u = 1.2, d = 0.9.
• Riskfree rate per period: 10%.
• Exercise price: 100.
Describe the optimal exercise policy.
(b) Keeping the other parameters constant, calculate the put price when the initial
stock price is 90 and 110 respectively. Interpret.
(c) Keeping the other parameters constant, calculate the put price when the strike
price is 90 and 110 respectively. Interpret.
(d) Keeping the other parameters constant, calculate the put price when d is 0.8 and
0.95 respectively. Interpret.

1
(e) Keeping the other parameters constant, calculate the put price when u is 1.15
and 1.3 respectively. Interpret.

Turn in a printout of your spreadsheet for each of the 9 cases above.


Hint: Make sure you define Excel functions in such a way that you don’t have to redo
your work in each part. You may find it useful to note that the stock price at any node
of the tree is of the form uk dn−k S, where S is the initial stock price, k is the number of
up moves, and n is the date (n = 0, 1, 2, 3, 4). You should also use the Excel function
max in order to calculate the value of each node under the optimal exercise policy.

You might also like