Describe the reason for the Poisson distribution to be a good choice for the given probability distribution r .

Question

Problem 1.We consider a two-period binomial model with the following properties: each period lastsone (1) year and the current stock price is S0 = 4. On each period, the stock price doubleswhen it moves up and is reduced by half when it moves down. The annual interest rateon the money market is 25%. We consider four options on this market: A European call option with maturity T = 2 years and strike price K = 5; A European put option with maturity T = 2 years and strike price K = 5; An American call option with maturity T = 2 years and strike price K = 5; An American put option with maturity T = 2 years and strike price K = 5.(a) Find the price at time 0 of both European options.(b) Find the price at time 0 of both American options. Compare your results with (a)and comment.(c) For each of the American options, describe the optimal exercising strategy.(d) We assume that you sell the American put to a market participant A for the pricefound in (b). Explain how you act on the market…

Answer 1

Question

Chapter 5, Problem 16CRP

a.

To determine

Describe the reason for the Poisson distribution to be a good choice for the given probability distribution r.

b.

To determine

Calculate the probability of no accidents in 100,000 flight operations.

c.

To determine

Calculate the probability of at least 4 accidents in 200,000 flight operations.

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