Assume that the periodic risk free rate is 5 a Construct a 2 period binomial

# Assume that the periodic risk free rate is 5 a

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8. Assume that the periodic risk free rate is 5%. (a) Construct a 2 period binomial tree on ABC’s stock. (b) What is the value of a call option on ABC’s stock with an exercise price equal to e 180 maturing after 2 periods? (c) CBOT (Chicago Board of Trade) is also offering a new exotic Down-and-Out call option for ABC. This option matures after 2 periods and has an exercise price equal to e 180. The difference is, however, that a Down-and-Out option immediately expires (be- comes worthless) if the share price drops below some predefined level, in this case e 185. What is the value of this Down-and-Out option today? 3. XYZs stock price is today e 80. Its volatility is 37% p.a. The annually compounded risk free rate is 3%. (a) Construct a two period binomial model to value a European call option with exercise price of e 85 that matures two years from now. 1 (b) You notice that the two year call with exercise price e 85 is trading at e 13. Is there an arbitrage opportunity? If no, explain why not. #### You've reached the end of your free preview.

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