We consider a one-step binomial tree in which the parameters are u = 1.2, d = 0.8, r = 0.12, T= 0.25, fu = 3, fa = 0. Evaluate the followings: (1) Calculate the probability p of an up movement in a risk-neutral world. (2) Compute the current price f.

We consider a one-step binomial tree in which the parameters are u = 1.2, d = 0.8, r = 0.12, T= 0.25, fu = 3, fa = 0. Evaluate the followings: (1) Calculate the probability p of an up movement in a risk-neutral world. (2) Compute the current price f.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter3: Risk And Return: Part Ii

Section: Chapter Questions

Problem 2P: APT An analyst has modeled the stock of Crisp Trucking using a two-factor APT model. The risk-free...

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Concept explainers

Risk and return

Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.

Capital Asset Pricing Model

Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.

Question

We consider a one-step binomial tree in which the parameters are
u = 1.2,
d = 0.8,
r = 0.12, T = 0.25, fu = 3, fa = 0.
Evaluate the followings:
(1) Calculate the probability p of an up movement in a risk-neutral world.
(2) Compute the current price f.

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