- CFA Exams
- CFA Level I Exam
- Study Session 16. Derivatives
- Reading 49. Basics of Derivative Pricing and Valuation
- Subject 11. Binomial Valuation of Options

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**CFA Practice Question**

Assume a stock price is $50 and that in the next year it will either rise by 20% or fall by 10%. The risk-free interest rate is 6%. A put option on this stock has an exercise price of $50. If we use a one-period binomial model, what should be the hedge ratio?

A. -0.33

B. 0.5333

C. 1.89

**Explanation:**μ = 1.2 and d = 0.9

S

^{+}= 50 x 1.2 = 60

S

^{-}= 50 x 0.9 = 45

p

^{+}= Max (0, 50 - 60) = 0

p

^{-}= Max (0, 50 - 45) = 5

n = (p

^{+}- p

^{-}) /(S

^{+}- S

^{-}) = -0.333

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**User Contributed Comments**
3

User |
Comment |
---|---|

frankal101 |
the delta for a put must be negative, so the numerator of the hedge ratio will be negative... A is the only negative answer... kinda of a roundabout way to answer, but hey if it saves you 1.5 minutes on the exam its well worth it... |

dblueroom |
does that mean the number of stock to short? |

ljamieson |
hedge ratio ~ delta: dc/dS |