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Calculate risk-neutral probability of up and down movement

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Reference no: EM133069922

Consider a stock whose current price is $200 per share. You would like to value an American call option on this stock that matures in two years. Assume that the strike price for this call option is $180 per share and that the stock can go up or down by 7% per period, where period is one year. Further, assume that the risk-free rate is 4% per annum with continuous compounding. Use a 2-step binomial tree to value this option.

  • Calculate risk-neutral probability of up and down movement in 1-period.
  • Construct binomial price tree. Draw the tree below and indicate stock prices at all nodes.
  • Calculate option values at maturity. Indicate your answers on the tree above.
  • Calculate option values at intermediate nodes. Indicate your answers on the tree above.
  • What is the value of this option as of today? Indicate your answer on the tree above
  • Would you exercise this option at any of the nodes on the binomial tree you constructed in part (a)? Explain

Reference no: EM133069922

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