FBE559.slides.07

5 103 solving q 03476 thus we can price the option

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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 0 1 (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 another period. 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: C0 25 0 1.1 1.1 Example (continued) Question: Wha...
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This document was uploaded on 10/28/2013.

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