Exam 4: Option Pricing Models: The Binomial Model

Determine the value of d for a four period binomial model when the option's life is one-fourth of a year and the volatility is 0.64. Use the model for u and d that does not require the risk-free rate.

Put-call parity holds within a two period binomial model.

In the binomial model, if an option has no chance of expiring out-of-the-money, the hedge ratio will be

The values of u and d are which of the following?

The binomial option pricing model will converge to what value as the number of periods increases?

If there is one period remaining and no possibility of the option expiring in-the-money, the hedge ratio will be zero.

In a recombining binomial model with n periods, the number of outcomes is n + 1.

The up and down factors in the binomial model are analogous to the volatility.

What would be the call's price if the stock goes down?

The binomial model will give a higher price for an American call on a stock that pays no dividends than if that call is European.

When calls are sold to adjust the hedge ratio, the funds must be placed in additional shares.

Options that can be priced by considering only the payoffs at expiration are called path-independent.

When pricing a put with the binomial model, the up and down probabilities are reversed.

In a non-recombining binomial model with n periods, the number of outcomes is 2n.

The formula for a hedge ratio of a put is the same as that of the call, except that put prices are used instead of call prices.

When the number of time periods in a binomial model is large, what happens to the binomial probability of an up move?

If a call is overpriced and you buy the call and sell short the stock, it is equivalent to investing money at less than the risk-free rate.

If the binomial model describes the real world, the combined actions of all investors will cause the market price to converge to the binomial price.

Over a large number of periods, the up and down parameters move closer to 1.5 and 0.5, respectively.

Pricing a put with the binomial model is the same procedure as pricing with a call, except that the