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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.
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.
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This document was uploaded on 10/28/2013.
- Spring '13