Hey guys I have a query regarding the derivation of the formula for u and d in the binomial tree model. Using equations (11.11) and (11.12) on pg 253....Hull goes on to show that exp(r*dt) (u+d) - ud = exp(2*r*dt) + sigma squared * dt however in the proof (Q&A Bank Part 2 Solutions Page 13 Step 1) they state that exp(r*dt) (u+d) - ud = exp(2*r*dt + sigma squared * dt) I have gone through the proof from the second equation and it seems fine. I also used the formula for u&d, plugged it into the first equation and got the answer in the first equation. Dont know whats going on...anyone?
Nevermind I worked it out, sorry. exp(2*r*dt) + sigma squared * dt = exp(2*r*dt + sigma squared * dt) if you expand the exp and omit terms higher than dt.
