Hi, For Q3 part (i) the derivative only pays out if S2<S0. In the q we don't know d or u...are we assuming (as we did in part (iii)) that the assumption ud=1 holds? If this didn't hold could we not end up with a situation where there is a payout in the middle node ie another situation where S2<S0? Assume d=0.89 and u =1.055, and S0=100, then in the middle node S2 = 100*0.89*1.055 = 93.895<100, and the bottom node S2 = 100*0.89^2 = 79.21? If we assume ud=1 then as per the solution the derivative only pays out after 2 down moves? Thanks, Darragh
The question does tie itself in knots by not specifying the size of ud relative to 1. I don't really want to bounce you to another form post (again!), but I think the issue is well covered here: https://www.acted.co.uk/forums/index.php?threads/april-2007_q3-i.5840/ Please let me know if you don't think this is the case.
