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Tutorial 3

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Desmond Lean
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Option and Bond Valuations AQ095-3-3 OBV Option Pricing using Binomial Trees

Tutorial 3

1. For an American call option on a stock, given stock price is $52, continuous dividend
rate is 10%, option expires in 6 months, strike price is $53, continuously compounded
risk-free interest rate is 3%. Option is modeled with a 2-period binomial tree in which
𝑢 = 1.3, 𝑑 = 0.8. Determine the call premium. Ans: 𝑪 = 𝟓. 𝟓𝟒𝟎𝟐𝟕

2. The spot exchange rate of dollars for euros is 1.15$/€. A 6-month American call
option allows purchase of euros at 1.25$/€. You are given 𝑟$ is 5% and 𝑟€ is 4%,
annual volatility of the exchange rate is 0.1. A 2-period binomial tree based on forward
prices is used to value the option. Determine the call option. Ans: 𝑪 = 𝟎. 𝟎𝟎𝟔𝟑𝟑

3. A 3-month American call option on a future contract is modeled with a 3-period


binomial tree. You are given binomial tree is based on forward prices, continuously
compounded risk-free rate is 5%, strike price is $60, future contract price is $60,
volatility is 0.3. Determine the call premium. Ans: 𝑪 = 𝟑. 𝟖𝟓𝟒𝟔𝟏

4. For a 1-year American call option on a future contract on gold, you are given the price
of future contract is $650 , strike price is $640 , volatility is 0.25 , continuously
compounded risk-free interest rate 4%. The option is modeled with 2-period binomial
tree based on forward prices. Determine the call premium. Ans: 𝑪 = 𝟔𝟑. 𝟎𝟐

5. Future prices of a stock are modeled with a 12-period binomial tree, each period being
one month. You are given the tree is constructed based on forward prices, initial stock
price is $72 , continuously compounded risk-free interest rate is 8% , stock pays
continuous dividends proportional to its price at a rate of 2%, volatility is 0.1. A
European put option on the stock expiring in one year has strike price $60. Calculate
the risk-neutral probability of a payoff from this option. Ans: 𝟎. 𝟎𝟎𝟑𝟔𝟕

6. Given current price of a share of 𝑋𝑌𝑍 Company stock is $100, over each of the next
two 6-months period, price is expected to go up by 10% or down by 10%, risk free
rate of interest is 6% p.a compounded semi-annually. Stock pays no dividends.
Determine the value of a 1-year American put option with a strike price of $115.
Ans: P = 15

7. For 𝑆 = 100, 𝑟 = 0.04, 𝛿 = 0, 𝜎 = 0.5 and ℎ = 0.5, determine 𝑆𝑢𝑑 using:


a) the forward price Ans: 𝟏𝟎𝟒. 𝟎𝟖𝟏
b) the Cox-Ross-Rubinstein tree Ans: 𝟏𝟎𝟎
c) the lognormal tree Ans: 𝟗𝟏. 𝟖𝟓𝟏𝟐

Level 3 Asia Pacific University of Technology & Innovation Page 1 of 1

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