Sep 2006 6(iv)?

The examiner's report approximates the exponential to write down the q and 1 - q probabilities, was there anything wrong in realizing that if S = 100 and Su = 110, then u = 1.1?

This leads to a straight - forward solution of the form

q = (e^rδt - d)/(u - d)

(e^rδt - exp(µδt - σ√δt )
q = --------------------------------------
((exp(µδt + σ√δt) - exp(µδt - σ√δt ))
​

Do you think this could have earned marks?

 

Not many, sorry. All you've really done is divide top and bottom by S.

You still need to expand the exponential terms (using a Taylor expansion) to get the answer "approximate to first order in δt".

 

Approximate was key word.