(a) An investment bank has issued a derivative on a share (with share price, S, of 100) that provides for the following

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A An Investment Bank Has Issued A Derivative On A Share With Share Price S Of 100 That Provides For The Following 1 (61.84 KiB) Viewed 10 times

(a) An investment bank has issued a derivative on a share (with share price, S, of 100) that provides for the following payoff after two months: F(S)=In(S-91) if S>91 = 0 otherwise You may assume that: • There exists a risk free asset that earns 5% per month, continuously compounded. The expected effective rate of return on the share is 2% per month. The monthly standard deviation of the log share price is 10%. • The stock pays no dividends. By using a two period recombining model of future share prices, derive the state price at time 2 months and using that state, calculate the value of the option at time zero. (7 marks)