Lecture 7: Binomial option pricing (cont'd)

Question 1

BOP - Risk neutral probability:

Q = [e^(rΔt) - d] / (u - d)

Answer 1

BOP - Risk neutral probability:

Q = [e^(rΔt) - d] / (u - d)

Question 2

Binomial Formula:

One period: c0 = e^(-rΔt) * [ Qc_u + (1-Q)c_d ]

Multi-period:
c_n = e^(-rΔt) * [ Qc_n+1(u) + (1-Q)c_n+1(d) ]

Answer 2

Binomial Formula:

One period: c0 = e^(-rΔt) * [ Qc_u + (1-Q)c_d ]

Multi-period:
c_n = e^(-rΔt) * [ Qc_n+1(u) + (1-Q)c_n+1(d) ]

Question 3

American Option payoff is maximum of the early exercise payoff or the PV of holding the option for an additional period.

Answer 3

American Option payoff is maximum of the early exercise payoff or the PV of holding the option for an additional period.