Question

ABC stock is currently trading at $100. In the next period, the price will either go up by 15% or down by 10%. The risk-free rate of interest over the period is 5%. Consider a call and a put option with $100 strike price with one-year maturity. Which of the following statement is false based on one period binomial option pricing model?

choices:

The synthetic call would include borrowing $48.86 at risk-free rate

The synthetic put would include investing $41.62 at risk-free rate

The synthetic call would include 0.6 unit of long underlying asset

The synthetic put would include 0.6 unit of short underlying asset

Answer 1

Answer : A - the systematic call would include borrowing $48.86 at risk free rate.

Explanation :

S0 = 100

S(head) = 115 S(tail) = 90

If call option bought, result would be,

S(head) = 15 S(tail) = 0 ( because option will not be exercised)

Value =

(Minus)   

Answer

=

Borrowing =

115(0.6) + B (1.05) = 15

B(1.05) = 0.6

B = 51.43

Borrowing require $51.43.

Hence 1st statement is wrong.

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