Exam 4: Option Pricing Models: the Binomial Model

A portfolio that combines the underlying stock and a short position in an option is called

If the number of binomial periods is increased and u,d and r are not adjusted,the value of a European call will increase.

In a multiperiod binomial model,an arbitrage profit cannot be earned until the option expires.

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

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

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.

The binomial probabilities are probabilities if investors were risk neutral.

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.

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

Now extend the one-period binomial model to a two-period world.Answer questions. -What is the value of the call if the stock goes up,then down?