5. A “cash-or-nothing binary stock option" is a European-style option and pays some fixed amount of cash to the holder at maturity T > 0 if the stock price at time T > 0 is above a certain threshold K (also referred to as the strike price). Suppose a stock price is currently at $50. Assume that over each of the next two 3-month periods the stock price will either go up by 6% or go down by 5%. The risk-free rate is 5% p.a. with continuous compounding. Use a two-step binomial tree model to compute the arbitrage-free price of a cash-or-nothing option written on that stock which pays $1 if the stock price in three months is above K = $50.

5. A “cash-or-nothing binary stock option" is a European-style option and pays some fixed amount of cash to the holder at maturity T > 0 if the stock price at time T > 0 is above a certain threshold K (also referred to as the strike price). Suppose a stock price is currently at $50. Assume that over each of the next two 3-month periods the stock price will either go up by 6% or go down by 5%. The risk-free rate is 5% p.a. with continuous compounding. Use a two-step binomial tree model to compute the arbitrage-free price of a cash-or-nothing option written on that stock which pays $1 if the stock price in three months is above K = $50.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter20: Financing With Derivatives

Section20.A: The Black-scholes Option Pricing Model

Problem 1P

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