[an error occurred while processing this directive]

#
Math 489/Math 889

Stochastic Processes and

Advanced Mathematical Finance

Dunbar, Fall 2010

###
Problem Statement

Consider a two-time-stage example. Each time stage is a year.
A stock starts at 50. In each year, the stock can go up by
10% or down by 3%. The interest rate on a $1 bond is constant
at 6% each year. Find the price of a call option with
exercise price 50, with exercise date at the end of the
second year. Also, find the replicating portfolio at each
node.

###
Solution

The solution is shown on the tree diagrammed below.

We can also use the risk-neutral probabilities to price the
binomial tree recursively as in the diagram below:

and

The portfolio amounts are also indicated at each node.

Back to main section with problem
statement

[an error occurred while processing this directive]
[an error occurred while processing this directive]

Last modified: [an error occurred while processing this directive]