109 April 2003 question 8

hi,

I am doing the online classroom binomial model part, the state deflator video. The question is April 2003 Q8 amended.

1. Also the q states the probability of an up jump is 60% - how do we know if this is the RN or RW probability of an up jump, ie. p or q? The Q assumes it's the RW probability but how would we know this is the questions doesn't state so.

2. Also,I just want to confirm - the condition u = d^-1 , only holds true for non-dividend paying shares? For a dividend paying share it no longer holds?

Thanks

 

1. up-step Risk Neutral Probability will always be as explained in the 'Binomial Option Pricing Model', so the given probability can be considered as up-step Real-World Probability.

2. Yes! as you can see with the given Formulae given in the tables. (dividend yield 'q'=0 for non-dividend paying shares)

 

Thanks!