This preview shows page 1. Sign up to view the full content.
Unformatted text preview: e.
Stock: S0 = 1.5 1.05S0 u
1.05S0 d This is exactly like if it were a stock with price S0 , S0 u , S0 d and it
paid a dividend out that was 5% of the future price. Option on a currency (continued) So to compute the option price we can solve for q :
1.6 = 1
(1.05 × q × 1.7 + 1.05 × (1 − q ) × 1.5)
1.03 Solving: q = 0.3476. Thus we can price the option:
Stock: C0 =??? C= 0.10
(q × (0.10) + (1 − q ) × 0) = 0.0338
1.03 Multi-period Binomial Model
We can also extend our model to have multiple periods.
First, lets go through the two-period steps again and then add
Example. Valuation of a European call on a stock.
Current stock price is $50.
There is one period to go.
Stock price will either go up to $75 or go down to $25.
There are no cash dividends.
The strike price is $50.
one period borrowing and lending rate is 10%. A New Example The stock and bond present two investment opportunities:
50 75 1 25 The option’s payoﬀ at expiration is:
1.1 Example (continued)
View Full Document
This document was uploaded on 10/28/2013.
- Spring '13