exercise_topic_06 - mium (see Economics of Financial...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
UNIVERSITY OF ESSEX DEPARTMENT OF ECONOMICS Session 2011–12 R. E. Bailey EC372 Economics of Bond and Derivatives Markets Exercise 6: Options Markets: II Price determination 1. Suppose that the current price of a stock is 120 pence per share and that the one-period interest rate is 10% with no compounding. In one period the price of the stock will become either 180 or 84. Use an arbitrage argument to calculate the price of a European call option which expires in one period with an exercise price of 158. [Hint: do not work out the decimal value of fractions until the final step (when they will all cancel out to give a simple result).] 2. Use an arbitrage argument to derive from first principles the expression for a call option pre-
Background image of page 1
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: mium (see Economics of Financial Markets , chapter 19 (section 19.2): c = c u + (1- ) c d R where c u and c d are dened by: c u = max [0 , uS-X ] in State 1 and c d = max [0 , dS-X ] in State 2 and R-d u-d and 1- u-R u-d . 3. Derive, using an arbitrage argument, the price of a European put option in the simple two-state model (see Economics of Financial Markets , chapter 19 (section 19.2): p = p u + (1- ) p d R where: p u = max [0 , X-uS ] in State 1 and p d = max [0 , X-dS ] in State 2. 4. Discuss the problems in applying the Black-Scholes model to predict traded options prices (for example, on LIFFE) in (a) the shares of companies, and (b) stock price indexes. *****...
View Full Document

Ask a homework question - tutors are online