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1) Binomial Pricing (3 points) Note: DerivaGem...




1) Binomial Pricing (3 points) Note: DerivaGem will not be helpful to solve this problem. You will have to reason it out without Derivagem. You will still need to do calculations, which can be done in Excel A stock is now selling for $30. Each month it will either increase or decrease in value by 10% (u = 1:1, d = 0:9). The riskless rate with continuous compounding is 5%. Now let us invent a new option, the Super Call Option, which is set up as a European-type contract. The Super Call Option will mature in three months and pay off [max{(K-S_T)/2; 0}]2 where S_T is the stock price at maturity and the strike price K equals $30. Use a 3-step binomial tree to answer the following questions a) At the current stock price, what position in stock and risk-free bonds would one have to take if one wished to replicate the Super Call Option?s payoff at maturity through a dynamic trading strategy? b) What is the cost of the replicating the portfolio today? c) How much is the Super Call Option worth today?


Paper#5643 | Written in 18-Jul-2015

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