Consider the following data (interest rate is per period): S = 100; K = 75;R= 1.20; u = 1.5; d = .5. 1. What is the binomial price of a European call option with two periods until expiration? What is the price an American option with the same strike price and same time to expiration. Is there ever early exercise? 2. Show that the binomial option price for a European put option with two periods to go until expiration is 3.125. Show that the binomial price for an American put is 6.25. Can you conclude from the difference in prices alone that early exercise may be optimal? When is it optimal? 3. Use your answers to (i) and (ii) to verify that put-call parity holds for European options, but not for American options. Explain all answers in detail or step by step solution.
Consider the following data (interest rate is per period): S = 100; K = 75;R= 1.20; u = 1.5; d = .5. 1. What is the binomial price of a European call option with two periods until expiration? What is the price an American option with the same strike price and same time to expiration. Is there ever early exercise? 2. Show that the binomial option price for a European put option with two periods to go until expiration is 3.125. Show that the binomial price for an American put is 6.25. Can you conclude from the difference in prices alone that early exercise may be optimal? When is it optimal? 3. Use your answers to (i) and (ii) to verify that put-call parity holds for European options, but not for American options. Explain all answers in detail or step by step solution.
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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Transcribed Image Text:Consider the following data (interest rate is per period):
S = 100; K = 75;R = 1.20 ; u = 1.5 ; d = .5.
1.
What is the binomial price of a European call option with two periods until expiration? What is the price an American option
with the same strike price and same time to expiration. Is there ever early exercise?
2.
Show that the binomial option price for a European put option with two periods to go until expiration is 3.125. Show that the
binomial price for an American put is 6.25. Can you conclude from the difference in prices alone that early exercise may be optimal? When is
it optimal?
3.
Use your answers to (i) and (ii) to verify that put-call parity holds for European options, but not for American options.
Explain all answers in detail or step by step solution.
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