Example hedging usc football risk suppose you are

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Unformatted text preview: Before we get to this, lets see how we can apply the two-period binomial pricing idea in other settings. Example: Hedging USC Football Risk Suppose you are considering buying a permit to sell USC Trojan t-shirts at the Rose Bowl game in January 2014. It will cost you $1000 to buy the permit and you must decide now. If USC makes it to the Rose Bowl, you figure that you will make a profit of $5500 selling t-shirts. However, if USC does not make it to the game, you will only make $500. USC has a decent chance to make the game, and a reputable betting house is offering 3:1 odds so that you can bet $100 in order to win $400. Alternatively, you can put your money into a savings account and get 0% interest. Do you: 1 Buy the permit 2 Don’t buy the permit 3 It depends on what you feel the chances are for USC making the game Example: Hedging USC Football Risk The payoffs for the permit, bet, and savings look like: Permit: 1000 5500 500 Bet: 0 400 -100 Save: 100 100 100 If we short-sell 10 bets on USC (∆ = 10), we fully hedge our risk. We will...
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