Could you help giving me explanations on this quant finance problem? Which of the following statement about the one-step binomial tree-model are correct ? Select all correct options. A. The stock's expected return does not play any role for the arbitrage-free pricing of an option written on the stock. B. Arbitrage-free prices of European stock options can be computed as expected values of the discounted payoff of the option of maturity by using the risk-neutral probability. C. The seller of a European stock option can perfectly hedge herself against the risk of paying the payoff to the holder of the option at maturity by implementing a hedging strategy which perfectly replicates the payoff at maturity by trading the underlying stock.

Could you help giving me explanations on this quant finance problem? Which of the following statement about the one-step binomial tree-model are correct ? Select all correct options. A. The stock's expected return does not play any role for the arbitrage-free pricing of an option written on the stock. B. Arbitrage-free prices of European stock options can be computed as expected values of the discounted payoff of the option of maturity by using the risk-neutral probability. C. The seller of a European stock option can perfectly hedge herself against the risk of paying the payoff to the holder of the option at maturity by implementing a hedging strategy which perfectly replicates the payoff at maturity by trading the underlying stock.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter8: Analysis Of Risk And Return

Section: Chapter Questions

Problem 12QTD

See similar textbooks

Similar questions

State whether the following statements are true or false. In each case, provide a brief explanation. a. In a risk averse world, the binomial model states that, other things being equal, the greater the probability of an up movement in the stock price, the lower the value of a European put option. b. By observing the prices of call and put options on a stock, one can recover an estimate of the expected stock return. c. An investor would like to purchase a European call option on an underlying stock index with a strike price of 210 and a time to maturity of 3 months, but this option is not actively traded. However, two otherwise identical call options are traded with strike prices of 200 and 220 respectively, hence the investor can replicate a call with a strike price of 210 by holding a static position in the two traded calls. d. In a binomial world,if a stock is more likely to go up in price than to go down, an increase in volatility would increase the price of a call option and reduce…
Under the assumptions of the Black-Scholes model, which value does not affect the price of a European call option: Select one: a. the interest rate r b. the spot price S c. the strike price K d. the return of the stock µ e. the volatility of the stock σ
In this problem, we derive the put-call parity relationship for European options on stocks that pay dividends before option expiration. For simplicity, assume that the stock makes one dividend payment of $D per share at the expiration date of the option.a. What is the value of a stock-plus-put position on the expiration date of the option?b. Now consider a portfolio comprising a call option and a zero-coupon bond with the same maturity date as the option and with face value (X + D). What is the value of this portfolio on the option expiration date? You should find that its value equals that of the stock-plus-put portfolio regardless of the stock price.c. What is the cost of establishing the two portfolios in parts (a) and (b)? Equate the costs of these portfolios, and you will derive the put-call parity relationship.
The binomial and Black-Scholes pricing models are the "guide posts" for pricing American and European options. Investors often consider employing stock options in their portfolios to minimize risk. They are viewed as "insurance" against losses in the portfolio. What are the pros and cons of the two models when pricing options? How would you incorporate the two models in your investment strategies/plans?
Which of the following is correct with regards to Theories of Term Structure? When the shape of the yield curve depends on investors’ expectations about prospective prevailing interest rates, the Pure Exception Theory is being applied. When the economic outlook is improving, the yield curve inverts as it reflects no changes in inflation premium. The liquidity preference theory suggests that long-term rates are generally higher than short-term rates since investors perceive more liquidity in long-term investments. Under the Market segmentation theory, there is an apparent relationship between the yield curve and the prevailing rate of returns in each market segment.
This is is the question related to the course "Financial Derivatives and Risk Management" Why are the probabilities of stock price movements not used in the binomialmodel for calculating an option’s price? What variables are used in it?
Is the Black-Scholes-Merton options pricing model well suited to pricing an American call option on a dividend paying stock?
For the cost of equity (stock) is it better to use the current US Treasury bill rate or a longer-termgovernment bond rate as the risk-free rate of return?
Which of the following statements is true? A. Because of flotation costs, dollars raised by retaining earnings must work harder than dollars raised by selling new shares. B. All other things being equal, a call option price will increase, and a put option price will decrease if an exercise price increases. C. Security market line (SML) plots return against total risk which is measured by the standard deviation of returns. D. Because potential long-term returns, income from rent-payments, diversification, and inflation hedge, real-estate would be a good investment.
Michael Weber, CFA, is analyzing several aspects of option valuation, including the determinants of the value of an option, the characteristics of various models used to value options, and the potential for divergence of calculated option values from observed market prices.a. What is the expected effect on the value of a call option on common stock if the volatility of the underlying stock price decreases? If the time to expiration of the option increases?b. Using the Black-Scholes option-pricing model and an estimate of stock return volatility, Weber calculates the price of a 3-month call option and notices the option’s calculated value is different from its market price. With respect to Weber’s use of the Black-Scholes option-pricing model,i. Discuss why the calculated value of an out-of-the-money European option may differ from its market price.ii. Discuss why the calculated value of an American option may differ from its market price.
Which of the following statements is correct? As the volatility of the stock price increases (all else remaining unchanged), both European calls and puts become less valuable. The seller of an option can choose whether to post a margin or not. Consider a call and a put which are both written on the same asset, and have the same strike price and the same time-to-maturity. It is possible for the call and the put to be out-of-the-money at the same time. The intrinsic value of a European option is the value it would have if the time-to-maturity was zero. Please explain and justify your choice using your own words.
Which of the following techniques is used to value stock options? a. Black-Scholes method b. Zero-coupon method c. Weighted-average method d. Expected earnings method