CT8 September 2011 Qu 9 (i) (b)

Discussion in 'CM2' started by Janboyd, Feb 23, 2019.

  1. Janboyd

    Janboyd Member

    The revision booklet says the first term in the expression corresponds to the value of the put option that makes a fixed payment of K if the share price at time T is below K but we have fixed payment K = 1000 and condition K = 2 so how come you can just put the K = 1000 rather than the 2 in the pricing formula?
     
  2. Furiously_treading_water

    Furiously_treading_water Active Member

    Picky me, but Question 8 :)
    I think I've worked it out: slightly unhelpful double-use of the letter K in the revision book. If we say instead that fixed payment is D, K is still used for the strike price of the stock in d2. So D=$1000 covers the size of the payment needed, K=$2 is still the benchmark to see whether D needs to be paid.

    D=1000
    K=2

    pt=D (e^(-0.02(2-t))) * PHI(-d2) where
    d2 = (ln(St/K) - 0.025(2-t))/0.3(root(2-t))
     

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