Exam 4: Option Pricing Models: the Binomial Model

The single period binomial hedge ratio for stock call options could be computed by equating the two future cash flows -- from a portfolio of long h shares of stock and short one call -- and solve for the number of underlying stocks to hold.

Consider a binomial world in which the current stock price of 80 can either go up by 10 percent or down by 8 percent.The risk-free rate is 4 percent.Assume a one-period world.Answer questions 12 through 15 about a call with an exercise price of 80. -What is the hedge ratio?

Consider a binomial world in which the current stock price of 80 can either go up by 10 percent or down by 8 percent.The risk-free rate is 4 percent.Assume a one-period world.Answer questions 12 through 15 about a call with an exercise price of 80. -What would be the call's price if the stock goes down?

Now extend the one-period binomial model to a two-period world.Answer questions 16 through 18. -What is the current value of the call?

When the number of time periods in a binomial model is large,a European call option value does what?

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

In a binomial model,if the call price in the market is higher than the call price given by the model,you should

When pricing an American put with the binomial model,you must check for early exercise at each time point and stock price except the current one.

Suppose S = 70,X = 65,r = 0.05,p = 0.6,C_u = 7.17,C_d = 1.22 and there is one period left in an American call's life.What will the option be worth?

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

In a one-period binomial model with S_u = 49.5,S_d = 40.5,p = 0.8,r = 0.06,S = 45 and X = 50,what is a European put worth?

If the binomial model is used with a specific dollar dividend and the stock price follows the up and down parameters,the tree will explode and end up with far more outcomes than time periods.

All of the following are practical applications of the binomial model except

Consider a binomial world in which the current stock price of 80 can either go up by 10 percent or down by 8 percent.The risk-free rate is 4 percent.Assume a one-period world.Answer questions 12 through 15 about a call with an exercise price of 80. -What is the theoretical value of the call?

If the stock price adjusted for dividends at a continuous rate follows the up and down parameters,the binomial tree will recombine.

When puts are priced with the binomial model,which of the following is true?

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

The hedge ratio is the number of shares per call in a risk-free portfolio.

The binomial option pricing formula will conform to the European lower bound.

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