The current price of a non-dividend-paying biotech stock is $140 with a volatili

Question

The current price of a non-dividend-paying biotech stock is $140 with a volatility of 25%. The risk-free rate is 4%. For a three-month time step: (a) What is the percentage up movement? (b) What is the percentage down movement? (c) What is the probability of an up movement in a risk-neutral world? (d) What is the probability of a down movement in a risk-neutral world? Use a two-step tree to value a six-month European call option and a six-month European put option. In both cases the strike price is $150.

Explanation / Answer

a) u=e.025´0.25= 1.1331. The percentage up movement is 13.31%

(b)d= 1/u= 0.8825. The percentage down movement is 11.75%

(c) The probability of an up movement is (e(0.004´0.25) -0.8825)/(1.1331 -0.8825)= 0.5089

(d) The probability of a down movement is0.4911.

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