What is the subsequent hedge ratio

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Reference no: EM131322214

Consider a two-period, two-state world. Let the current stock price be 45 and the risk-free rate be 5 percent. Each period the stock price can go either up by 10 percent or down by 10 percent. A call option expiring at the end of second period has an exercise price of 40.

Answer the following 3 questions below. PLEASE SHOW ALL WORK

1. What is the initial hedge ratio?

2. What is (are) the subsequent hedge ratio(s)?

3. Construct an example showing how the hedge works and illustrating how the hedge portfolio earns the risk-free rate in each period.

Reference no: EM131322214

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