2007 April Q3

Discussion in 'CM2' started by Darragh Kelly, Jul 4, 2022.

  1. Darragh Kelly

    Darragh Kelly Active Member

    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
     
  2. Steve Hales

    Steve Hales ActEd Tutor Staff Member

  3. Darragh Kelly

    Darragh Kelly Active Member

    Thanks v much Steve all clear now - Mike's explanation was perfect.

    Kind regards,

    Darragh
     

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