Chapter 11

Task 

In this assignment, you will solve problems on Binomial Option Pricing. 

Instructions 

1. Use your textbook to answer the following questions from Chapter 11:
   1. Exercise 9, 10, and 19.
2. Please, upload xls, xlsx file.
3. Please, use the full computing power of Excel.

 

9.   ABC stock is currently at 100. In the next period, the price will either increase by 10%

or decrease by 10%. The risk-free rate of return per period is 2%. Consider a call option

on ABC stock with strike K = 100.

(a) Set up a replicating portfolio to value the call.

(b) Suppose the call is trading for $7. Explain how you would exploit the resulting

arbitrage opportunity.

 

10.   ABC stock is currently at 100. In the next period, the price will either increase by 5% or

decrease by 5%. The risk-free rate of return per period is 3%. Consider a put option on

ABC stock with strike K = 100.

(a) Set up a replicating portfolio to value the put.

(b) Suppose the put is trading for $2. Explain how you would exploit the resulting

arbitrage opportunity

 

19.   Portfolio insurance: The current price of the stock we are holding is $100. We want to

continue to hold the stock position but modify it so that the portfolio value never drops

below $90. If the stock may move up to $130 or down to $80 after one period, how do

we modify our holding of $100 so as to make sure that it is at least of $90 value at the

end of the period? The rate of simple interest for the period is 10%.

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