FIN455 Assignment 4 - You are given the following information
Business Finance 455
Assignment-4
Fin 455
Spring 2024
1. You are given the following information: (use continuous compounding).
|
Current stock price |
$100 |
|
Strike price |
$100 |
|
Annual Volatility (σ) |
25% |
|
Annual Risk-Free rate |
5% |
|
Time to maturity |
3 months (0.25 years) |
|
Time step (Δt) |
1 month (1/12 years) |
|
Up parameter (U) |
|
|
Down parameter (D) |
1/U |
Compute the current value of a European call option.
2. A look back option is a call option that allows the holder to buy the stock at the minimum stock price that occurred over the period to expiration. Suppose, S0 = $129, U = 1.5, D = 0.5, and R = 1.1, use a 3-period binomial model and find the price of such a contract?
3. You are provided with the following information:
S0 = $129, X = $80, U = 1.5, D = 0.5, and R = 1.1
a) Compute the value of a call option using the two-period binomial model.
b) What are the hedge portfolios at t = 1 that help price the call option at that time?
c) Suppose the model price were correct, and the call option were priced in the market at $55. Show how one can make arbitrage profits.
4. Price a call option using the one-period binomial model assuming the following data:
S0 = 129, K=80, U=1.5, D=0.5 and R=1.1. What does the replicating portfolio consist of?
5. Use the data from problem 5, compute the put price and validate the put-call parity.
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Solution: FIN455 Assignment 4 - You are given the following information