. (Replicating strategy for pricing) To price a derivative, we can use risk-neutral pricing. As an alternative yet equivalent method, we can construct price the derivative using replicating strategies. Consider a 1-period binomial model, where we have three nodes No,0, N1,0, N1,1. We have a cash account with fixed interest rate r = 0.01 - that is, if we have at No,o cash account with D dollars, we expect (1 + r)D at either N1,0 or N1,1. We also have a stock with price S0,0 = 10 at No,0, S1,0 = 8 at N1,0 and $1,1 = 15 at N₁,1. Now consider an European call option at time t = 1 with strike K = 12. Can you price the option at No,o using a replicating strategy, and what is the price? Please submit your answer rounded to only one decimal digit - for example if your answer is 1.28, then submit 1.3. If your answer is 1.12, submit 1.1.

. (Replicating strategy for pricing) To price a derivative, we can use risk-neutral pricing. As an alternative yet equivalent method, we can construct price the derivative using replicating strategies. Consider a 1-period binomial model, where we have three nodes No,0, N1,0, N1,1. We have a cash account with fixed interest rate r = 0.01 - that is, if we have at No,o cash account with D dollars, we expect (1 + r)D at either N1,0 or N1,1. We also have a stock with price S0,0 = 10 at No,0, S1,0 = 8 at N1,0 and $1,1 = 15 at N₁,1. Now consider an European call option at time t = 1 with strike K = 12. Can you price the option at No,o using a replicating strategy, and what is the price? Please submit your answer rounded to only one decimal digit - for example if your answer is 1.28, then submit 1.3. If your answer is 1.12, submit 1.1.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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The possible returns of a security I and research returns under three possible states are as follows. Probability % market % security 0.2 15 10 0.5 13 16 0.3 25 30 The risk free rate is 9%, determine the required rate of return of security I and sate whether it is correctly valued. 12-marks] 20 Ri= E(R) XW
A forward contract has an underlying asset which, in Cox-RossRubenstein notation, has S=22,u=1.2 and d=0.9. This forward contract matures in one time step and the return over this time step is R=1.02. Assuming the forward price is calculated rationally, what is the value of the forward at node (1,1)? (Give your answer as a positive number.)
The lower the discount rate used: Select one: A. the bigger the present value of future cash flows and the shorter the payback time. B. the smaller the present value of future cash flows and the shorter the payback time. C. the bigger the present value of future cash flows and the longer the payback time. D. the smaller the present value of future cash flows and the longer the payback time.
Assume an interest rate of zero. A Call option and a Put option with the same exercise price, X = 100p are priced at 9p for the Call and 4p for the Put. By completing the table below (attached) show that the net position at expiry is zero.
Put–Call Parity - A put and a call have the same maturity and strike price. If they have the same price, which one is in the money? Prove your answer and provide an intuitive explanation.
2. Suppose that you have a riskfree asset and N risky assets for investment. The rate of return on the riskfree asset is r,, while the (Nx1) vector of the rate of return on the N risky assets is r, which is multivariate normal, i.e., r N(u, E). Your utility function for a portfolio that consists of the riskfree asset and the N risky asset is u(r,)=r,-=o, 2 Suppose that the sum of investment proportions on the riskfree and risky assets is one. Answer the following question. A. What is your optimal investment proportion in the risky assets? How is your investment on the riskfree asset affected by different values of 2? B. Suppose that there is only one risky asset i. Show the effects of the Sharpe ratio (4,/0, ) on the investment proportion in the risky asset.
An advantage of the internal rate of return method is that a.it considers the time value of money. b.it can rank proposals of equal lives. c.it considers the cash flows of the investment. d.All of these choices are correct.
A project's internal rate of return (IRR) is the discount rate YTM on a bond. The equation for calculating the IRR is: timing Project A Project B 0 1 2 CFt is the expected cash flow in Period t and cash outflows are treated as negative cash flows. There must be a change in cash flow signs to calculate the IRR. The IRR equation is simply the NPV equation solved for the particular discount rate that causes NPV to equal zero 320 255 The IRR calculation assumes that cash flows are reinvested at the IRR If the IRR is greater ✔than the project's risk-adjusted cost of capital, then the project should be accepted; however, if the IRR is less than the project's risk-adjusted cost of capital, then the project should be rejected ✓✓✓. Because of the IRR reinvestment rate assumption, when mutually exclusive projects are evaluated the IRR approach can lead to conflicting results from the NPV method. Two basic conditions can lead to conflicts between NPV and IRR: ✔ differences (earlier cash flows in…
Which of the following statements is true? Multiple Choice When NPV is 0, the IRR is equal to the discount rate. When NPV is 0, the investment is not making a profit. In calculating IRR, we make the assumption all cash flows are reinvested at the discount rate. NPV is a good measure to use when comparing investments of different sizes.
7. Suppose the modeling is that t → T. (a) What is the value of a Call? (b) What is the value of a Put? (c) Explain both answers in terms of finance.
Capital asset pricing model (CAPM) For the asset shown in the following table, use the capital asset pricing model to find the required return. (Click on the icon here in order to copy the contents of the data table below into a spreadsheet.) Risk-free rate, RF 1% The required return for the asset is %. (Round to two decimal places.) C Market return, m 5% Beta, b 0.5
A single mispriced asset has an alpha a = 3.0%, a beta ẞ = 1, and unsystematic risk σ² = 9%. The market risk premium is 5.0% and the market's standard deviation is 0.1. What is the information ratio of the mispriced asset? In constructing an optimal allocation between this mispriced asset and the market portfolio, what proportion of your investment would you place in the mispriced asset? Oa. 0.1; 6.67% O b. 0.33; 6.67% O c. 0.33; 6.90% O d. 0.1; 66.67% O e. 0.1; 6.90%

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