QuestionWhich of the following statement(s) is/are true regarding a single-period binominal model with a time period h?I) If X is the expected payoff of a European option in the real world, then the price of the option can be obtained bydiscounting X at the risk-free interest rateII) To calculate the risk-neutral probability of an increase in stock price, the risk premium of the stock is neededII) In the risk-neutral world, the expected stock price at time h is the forward price for the stock delivering at time hPossible AnswersA 1) onlyB III) onlyC I) and II) onlyD 1) and III) onlyE None of the statement is true

The question is based on the fundamental principle for the valuation of derivative contracts, mainly…

Answered: Which of the following statement(s)…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter8: Analysis Of Risk And Return

Section: Chapter Questions

Problem 1P

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In a binomial tree created to value an option on a stock, what is the expected return on the option? O Zero O The return required by the market O The risk-free rate O It depends on the volatility AL
In a binomial option pricing model, when moving from valuing an option on a non-dividend paying stock to an index option which of the following is true for estimating uptick probability P? O The risk-free rate be replaced by the excess of the foreign risk-free rate over the domestic risk-free rate when p is calculated. O The formula for u changes. O The risk-free rate is replaced by the excess of the domestic risk-free rate over the dividend yield for discounting. O The risk-free rate is replaced by the excess of the domestic risk-free rate over the foreign risk-free rate in all calculations.
Select the best answer with respect to a stock's "alpha"? (In a CAPM world) Group of answer choices The expected return on an asset relative to the expected return on the market The expected return on an asset relative to the riskiness of the asset The expected return on an asset relative to the risk free rate The expected return on an asset relative to what CAPM predicts for the asset's expected return
Under the assumptions of the Black-Scholes model, which value does not affect the price of a European call option: Select one: a. the interest rate r b. the spot price S c. the strike price K d. the return of the stock µ e. the volatility of the stock σ
In this problem, we derive the put-call parity relationship for European options on stocks that pay dividends before option expiration. For simplicity, assume that the stock makes one dividend payment of $D per share at the expiration date of the option.a. What is the value of a stock-plus-put position on the expiration date of the option?b. Now consider a portfolio comprising a call option and a zero-coupon bond with the same maturity date as the option and with face value (X + D). What is the value of this portfolio on the option expiration date? You should find that its value equals that of the stock-plus-put portfolio regardless of the stock price.c. What is the cost of establishing the two portfolios in parts (a) and (b)? Equate the costs of these portfolios, and you will derive the put-call parity relationship.
What impact does each of the followingparameters have on the value of a call option?(1) Current stock price
Which of the following is NOT always positively related to the price of a European call option on a stock? a) The time to expiration b) The volatility c) The risk-free rate d) The stock price
1. Consider a family of European call options on a non - dividend - paying stock, with maturity T, each option being identical except for its strike price. The current value of the call with strike price K is denoted by C(K) . There is a risk - free asset with interest rate r >= 0 (b) If you observe that the prices of the two options C( K 1) and C( K 2) satisfy K2 K 1<C(K1)-C(K2), construct a zero - cost strategy that corresponds to an arbitrage opportunity, and explain why this strategy leads to arbitrage.
Explain in detail with an example how the change of the variables (like Stock Price, Exercise Price, Risk-Free Rate, Volatility or Standard Deviation, and Time to Expiration) of Black-Scholes-Merton Formula affect the price of the option.
The market portfolio (M) has the expected rate of return E(rM) = 0.12. Security A is traded in the market. We know that E(rA) = 0.17 and βA = 1.5. (1) What is the rate of return of the risk-free asset (rf)? (2) Security B is also traded in the market. βB = 0.8. Then what is “fair” expected rate of return of security B according to the CAPM? (3) Security C is a third security traded in the market. βC = 0.6, and from the market price, investors calculate E(rC) = 0.1. Is C overpriced or underpriced? What is αC?
Which of the following is true: The BSM model combined with the put call parity can be used to give the theoretical price of an American put option. One of the variables that influences the price of the option is the expected return on the stock. Since dividends could trigger an early exercise of an American call, the BSM formula dividend adjustment will provide the correct price of an American call. The BSM formula requires cumulative probabilities from the lognormal distribution. The BSM model may be used with currency options by replacing the dividend yield with the foreign interest rate.

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