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Consider a binomial world in which the current stock price of 80 can either go up...

Consider a binomial world in which the current stock price of 80 can either go up by 10 percent or down by 8 percent. The risk-free rate is 4 percent. Assume a one-period world. Answer questions 12 through 15 about a call with an exercise price of 80.What is the hedge ratio if the stock goes down one period? 2 period

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Expert Solution

Strike price =       $ 80.00   
Current Market price =       $ 80.00   
Risk-free rate = 4%          
Value of call option formula = stock price - strike price      

At one peripd, value of option

Stock price =   88      
(80+10%)          
Value of call option = 88-80 = 8          
          
Stock price    73.6      
(80-8%)          
Value of call option = 73.6 - 80 = 0          

   Hedge ratio formula = (V.C. at Upper value -V.C. at Down value) / (Upper Value - Down value)      
   (8-0) / (88-73.60)  
   0.5555555556           

So, hedge ratio is 0.56

jeff jeffy answered 2 years ago
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