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a) Write the payoff of the European call option with strike price K. b) Assume d = 5, r = 0.2, d₁ = 3, d₂ = 8, K = 7. Find the price of the option. c) Find the replicating strategy for the option.

a) Write the payoff of the European call option with strike price K. b) Assume d = 5, r = 0.2, d₁ = 3, d₂ = 8, K = 7. Find the price of the option. c) Find the replicating strategy for the option.

Corporate Fin Focused Approach
Corporate Fin Focused Approach
5th Edition
ISBN:9781285660516
Author:EHRHARDT
Publisher:EHRHARDT
Chapter6: Risk And Return
Section: Chapter Questions
Problem 1Q
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Consider a financial market consisting of a bank account So(t) and a stock S₁ (t) modelled on a probability space (2, F, P) with the time indices t = 0, 1, 2, ..., T. consider a one period financial market model with T = 1, S = {w₁, W₂}, F is the collection of all events and P is a probability measure such that P({w₁}) > 0, P({₂}) > 0. Assume that So(0) = 1, S₁ (0) = d> 0 and So(1,₂)= (1+r) So(1, ₁) = S₁(1, ₁) = S₁ (1, ₂) = where 0 < d <d₂. r> 0 is the interest rate. Question: d₁, d₂, a) Write the payoff of the European call option with strike price K. b) Assume d = 5, r = 0.2, d₁ = 3, d₂ = 8, K = 7. Find the price of the option. c) Find the replicating strategy for the option.
Transcribed Image Text:Consider a financial market consisting of a bank account So(t) and a stock S₁ (t) modelled on a probability space (2, F, P) with the time indices t = 0, 1, 2, ..., T. consider a one period financial market model with T = 1, S = {w₁, W₂}, F is the collection of all events and P is a probability measure such that P({w₁}) > 0, P({₂}) > 0. Assume that So(0) = 1, S₁ (0) = d> 0 and So(1,₂)= (1+r) So(1, ₁) = S₁(1, ₁) = S₁ (1, ₂) = where 0 < d <d₂. r> 0 is the interest rate. Question: d₁, d₂, a) Write the payoff of the European call option with strike price K. b) Assume d = 5, r = 0.2, d₁ = 3, d₂ = 8, K = 7. Find the price of the option. c) Find the replicating strategy for the option.
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