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14 November, 08:41

If the volatility of a stock is 20% per annum and a risk-free rate is 5% per annum, which of the following is closest to the Cox, Ross, Rubinstein parameter p for a tree with a three-month time step?

A) 0.50

B) 0.54

C) 0.58

D) 0.62

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Answers (1)
  1. 14 November, 09:05
    0
    B. 0,54

    Explanation:

    Step 1. Given information.

    Volatitlity = 20% Time = 3/12 =.25 Interest rate = 5%

    Step 2. Formulas needed to solve the exercise.

    u = e volatiltiy * (time).5

    a = e rate * time

    p = (a - d) / (u - d)

    Step 3. Calculation.

    u = e 0.2 * (.25).5

    u = 1.105170918

    d = 1/u

    d =.904837418

    a = e rate * time

    a = e 0.05 *.25

    a = 1.012578452

    p = (a - d) / (u - d)

    p = (1.012578452 - 0.904837418) / (1.105170918 - 0.904837418)

    p =.538 =.54

    Option B
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