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There are some similarities between Binomial Option Pricing Model and Black-
Scholes Option Pricing Model, which are as:
1. Both these models assume there are no arbitrage opportunities that exist in
the market
2. Both the models assume that the price movement of the underlying stock is
uncertain and random
Differences between Binomial Option Pricing Model and Black-Scholes Option Pricing
Model:
In contrast to the Black-Scholes model, which provides a numerical result based on
inputs, the binomial model allows for the calculation of the asset and the option for
multiple periods along with the range of possible results for each period
According to the given situation:
Current Stock price = Rs 500
Strike price for a 3-month European call option = Rs 520
Risk free interest rate = 6%
Stock Price = Rs500
Option value = f
The portfolio will be risk-free when, 550x-30 = 450x.
Or, x = 0.3.
The value of the portfolio at the time of expiry = 550x – 30 = 450x = Rs 135
Present value of the portfolio = 135*exp(-0.06*0.25) = Rs 132.99
Present value of the shares held = 0.3 *500 = Rs 150
Present value of the European call option, f = PV of shares held – PV of the portfolio =
Rs 150 – Rs 132.99 = Rs 17.01
Answer 2:
a) Company
Company A B
Fund
Required 100 100
Fixed Rate 7% 8.50%
Floating Rate MIBOR+0.5% MIBOR+1%
Total Benefit 1%
Benefit for
Kotak 0.10%
Benefit for A 0.45%
Benefit for B 0.45%
Answer 3:
STRADDLE:
Premium 4.77
Stock Price at P(T) at 40 C(T) at 40 CF(T) CF(0) Total
Expiration Put Call profit
34 6 0 6 -4.77 1.23
35 5 0 5 -4.77 0.23
36 4 0 4 -4.77 -0.77
36.64 3.36 0 3.36 -4.77 -1.41
37 3 0 3 -4.77 -1.77
38 2 0 2 -4.77 -2.77
39 1 0 1 -4.77 -3.77
40 0 0 0 -4.77 -4.77
41 0 1 1 -4.77 -3.77
42 0 2 2 -4.77 -2.77
43 0 3 3 -4.77 -1.77
43.36 0 3.36 3.36 -4.77 -1.41
44 0 4 4 -4.77 -0.77
45 0 5 5 -4.77 0.23
46 0 6 6 -4.77 1.23
STRANGLE:
Premium- 1.41
Stock Price at P(T) at 35 C(T) at 45 Total
Expiration Put Call CF(T) CF(0) profit
32 3 0 3 1.41 1.59
33 2 0 2 1.41 0.59 Straddle values
34 1 0 1 1.41 -0.41 1.23
35 0 0 0 1.41 -1.41 0.23
36 0 0 0 1.41 -1.41 -0.77
36.64 0 0 0 1.41 -1.41 -1.41
37 0 0 0 1.41 -1.41 -1.77
38 0 0 0 1.41 -1.41 -2.77
39 0 0 0 1.41 -1.41 -3.77
40 0 0 0 1.41 -1.41 -4.77
41 0 0 0 1.41 -1.41 -3.77
42 0 0 0 1.41 -1.41 -2.77
43 0 0 0 1.41 -1.41 -1.77
43.36 0 0 0 1.41 -1.41 -1.41
44 0 0 0 1.41 -1.41 -0.77
45 0 0 0 1.41 -1.41 0.23
46 0 1 1 1.41 -0.41 1.23
47 0 2 2 1.41 0.59
48 0 3 3 1.41 1.59
49 0 4 4 1.41 2.59
50 0 5 5 1.41 3.59
51 0 6 6 1.41 4.59
0