The current spot price of an asset is S0 = $50. Each month the price could increase to 1.10 times its current value

Question

The current spot price of an asset is S0 = $50. Each month the price could increase to 1.10 times its current value (u=1.10) , or it could decrease to (1/1.10) times its current value (d=1/1.10) The interest rate is 25 basis points per month. Q1. What is the risk neutral probability and the forward price F2?

Help In Homework · Accepted Answer

Facts Spot $ 50 Interest 0.25% per month Term 1 MONTH Answer Upper FSP Spot*1.1 =$50*(1.1) = $ 55 Downward FSP Spot/1.1= $ 45 i. Risk Neutral Probability P= (e^t*rf-d)/(u-d) u= Upper FSP/Spot = 55/50 = 1.1 d=Downward FSP/Spot = 45/50 = 0.9 e^0.25 =1.284 P= (e^t*rf-d)/(u-d) = (1.284-0.9)/(1.1-0.9) P= 1.92 1-P=1-1.92=-0.92 ii. Forward Price Forward Price = Spot * e^tr Forward Price = 50* e^0.25 Forward Price = 50* 1.284 = 64.2

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The current spot price of an asset is S0 = $50

Expert Solution

Archived Solution

Facts

	Spot	$ 50
	Interest	0.25%	per month
	Term	1 MONTH

	Answer

	Upper FSP	Spot*1.1	=$50*(1.1) = $ 55
	Downward FSP	Spot/1.1= $ 45

	i. Risk Neutral Probability

	*P= (e^trf-d)/(u-d)**

	u= Upper FSP/Spot = 55/50 = 1.1
	d=Downward FSP/Spot = 45/50 = 0.9

	e^0.25 =1.284

	*P= (e^trf-d)/(u-d) = (1.284-0.9)/(1.1-0.9)**
	P= 1.92

	1-P=1-1.92=-0.92

	ii. Forward Price

	Forward Price = Spot * e^tr
	Forward Price = 50* e^0.25
	Forward Price = 50* 1.284 = 64.2