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Use a 2 step binomial tree to value a new exotic derivative. Draw the tree and...

Use a 2 step binomial tree to value a new exotic derivative. Draw the tree and label the stock prices and derivative values at each node. The option expires in 6 months. The interest rate is 10% annually continuously compounded. The Strike Price (K) is 100. The spot price is at 100. U= 1.2 and D= 0.8 for each quarterly period. The payoff of this derivative is (ST/K). By this I mean that the payoff is the price of the underlying stock divided by the Strike Price.

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  • The stock price values include 100, 120, 80, 144, 96 and 64
  • The derivative value includes assuming it to be call option - 15.71033, 26.29172, 0, 144, 0, 0 at different nodes in the two-step model.

The concept, calculation and the tree are explained in the images below:

jeff jeffy answered 1 year ago
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