Tom Curtis has prepared a hypothetical problem for you and your group
to solve. He wants you to utilize the two-period binomial option
pricing model to solve certain problems. If your team passes this test,
you might soon be developing derivative strategies for Ricardo
International to use.
Individual Portion – 700 words
Individually conduct research on two different models used to price
call options. Detail each model in a Word document and focus on
comparing and contrasting the models. Post your document to the Small
Group Discussion Board.
Team work – 1500 words
As a group, combine your efforts to solve the following:
Consider a two-period, two-state world. Let the current stock price
be $35 and the risk-free rate be 5%. In each period, the stock price can
either go up by 10% or down by 10%. A call option expiring at the end
of the second period has an exercise price of $30.
- Find the stock price sequence. Explain. (300 words)
- Determine the possible prices of the call at expiration. Explain (300 words)
- Find the possible prices of the call at the end of the first period. Explain (300 words)
- What is the current price of the call? Explain (300 words)
- What is the initial hedge ratio? Explain (300 words)