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