Nov 13 Mock Test IV: Afternoon Session Q3

kspoon
Posts: 6
Joined: Wed Apr 04, 2012 12:33 am

Nov 13 Mock Test IV: Afternoon Session Q3

Postby kspoon » Fri May 18, 2012 8:02 am

Hi,

For Q3 of the Mock Test IV Afternoon Session, the answer is given as:

F = e^-rT[1.0034*0.5756 + 6*0.4244]

Where did the term 1.0034 come from? Since the U factor is 1.1, if the underlying stock goes up, it will be at $44, which is above the strike price, so the value of the Put option should be 0. Shouldn't the answer be:

F = e^-rT[0*0.5756 + 6*0.4244]?

Thanks in advance.

suresh.wadhwani2009
Finance Junkie
Posts: 99
Joined: Sat Apr 07, 2012 10:24 am

Re: Nov 13 Mock Test IV: Afternoon Session Q3

Postby suresh.wadhwani2009 » Fri May 18, 2012 10:22 am

This is 2 step binomial model. In firsst 3 months price can go to 44 or 36. now from 44 in next three months it can go to 48.4 or 39.6

so the value of call at 44 will be 1.0034 as there ia possibility that in next 3 months price from 44 will go down 10% to 39.6 which is beneficial. m not calculating here that how 1.0034 comes. If any difficulty in that then tell.. i'll attache d whole soln.

Though the calculation be pristine at end stage is wrong. Instead of 6 there should be 5.374

hope it helps!


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