A Tree Is Constructed to Value an Option on an Index

question 19

Multiple Choice

A tree is constructed to value an option on an index which is currently worth 100 and has a volatility of 25%. The index provides a dividend yield of 2%. Another tree is constructed to value an option on a non-dividend-paying stock which is currently worth 100 and has a volatility of 25%.

• A) The parameters p and u are the same for both trees
• B) The parameter p is the same for both trees but u is not
• C) The parameter u is the same for both trees but p is not
• D) None of the above

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Definitions:

Miller-Orr Model

A financial model used to manage cash flows and determine the optimal cash balance levels for a company, focusing on cost minimization.

Lower Limit

The minimum value in a range of acceptable or possible values, often used in statistics and quality control.

Target Cash Balance

The ideal amount of cash that a company aims to maintain in order to manage daily financial operations and contingencies effectively.

Collection Float

The amount of time it takes for money from checks or other types of payments to be processed and available in the company’s account.