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Tutorial 2

Uploaded by

Desmond Lean
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© © All Rights Reserved
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Download as PDF, TXT or read online on Scribd
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Option and Bond Valuations AQ095-3-3 OBV Binomial Trees

Tutorial 2

1. A 1-year European put option on a non-dividend paying stock has a strike price of $50.
You are given current stock price is $50. At the end of the year, stock price will be
either $40 or $60, risk-free rate is 5%. Determine premium for the put.
Ans: 𝑷 = 𝟑. 𝟓𝟑𝟔𝟗

2. A 1-year European put option on a non-dividend paying stock has a strike price of $50.
You are given current stock price is $50. At the end of the year, stock price will be
either $40 or $60, risk-free rate is 5%. The replicating portfolio consists of Δ shares of
stock and of lending 𝐵. Determine 𝛥 and 𝐵. Ans: 𝚫 = −𝟎. 𝟓, 𝐁 = 𝟐𝟖. 𝟓𝟑𝟔𝟗

3. A 1-year European put option on the above stock with a continuous dividend rate of
2%, stock has a strike price of $55. You are given current stock price is $50, at the end
of the year, stock price will be either $40 or $60, risk-free rate is 5%. Calculate the
replicating portfolio and derive option premium from it. Should you get the answer
when you use put-call parity to calculate the premium for the put.
Ans: 𝚫 = −𝟎. 𝟕𝟑𝟓𝟏𝟓, 𝐁 = 𝟒𝟐. 𝟖𝟎𝟓𝟑𝟐, 𝐏 = 𝟔. 𝟎𝟒𝟕𝟗

4. Stock prices are modeled with the following 1-period binomial tree, the period being 6
months, current stock price is $50, strike price is $52. At the end of 6-months, stock
price will be either $65 or $40, continuously compounded risk-free interest rate is 6%.
Determine the change in the premium for the call option if continuous dividend rate for
the stock increases from 0% to 2%. Ans: −𝟎. 𝟐𝟓𝟖𝟕

5. Future prices of stock are modeled with a 1-period binomial tree based on forward
prices, the period being one year. Current stock price is $40, continuously compounded
risk-free interest rate is 5%, stock pays continuous dividend proportionate to its price
at a rate of 2%, volatility is 30%. Determine the risk-neutral probability of an increase
in stock price. Ans: 𝒑∗ = 𝟎. 𝟒𝟐𝟓𝟓𝟔

6. The price of a non-dividend paying stock is modeled by 1-period binomial tree with the
period being one year, current stock price is $30. At the end of the year, stock price
will be either $40 or $25, continuously compounded risk-free interest rate is 4%. A
European call option expiring in one year on stock has a strike price of $30. Determine
𝟐
the number of shares of stock in replicating portfolio for call option. Ans: 𝜟 = 𝟑

7. Stock price of a non-dividend paying stock is modeled by 1-period binomial tree with
the period being 6-months. At the end of 6-months, stock price will be either $100 or
$50, continuously compounded risk-free interest rate is 5%. The price of a European
call option expiring in 6 months with strike price $60 is $1. Determine the price of the
stock. Ans: 𝐒𝟎 = 𝟓𝟎. 𝟎𝟏𝟓𝟓

8. In a one-period binomial tree for stock prices, you are given the period of tree is 6
months, 𝑆0 is the initial price of the stock. Price of stock may be 0.8𝑆0 or 1.2𝑆0 at the
end of the period. Determine the volatility of the stock price. Ans: 𝝈 = 𝟎. 𝟐𝟖𝟔𝟕

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

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