Suppose You Were Replicating a Two-Period Put Option in a Binomial

question 3

Multiple Choice

Suppose you were replicating a two-period put option in a binomial tree.Then,the replicating strategy involves an initial short position in the underlying stock that

• A)is held unchanged to maturity.
• B)is increased in size (i.e. ,becomes more short)after one period.
• C)is increased in size (i.e. ,becomes more short)if the price goes down in the first period and decreased in size (becomes less short)if the price goes up in the first period.
• D)is decreased in size (i.e. ,becomes less short)if the price goes down in the first period and increased in size (becomes more short)if the price goes up in the first period.

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Definitions:

Marginal Cost

The augmentation in cumulative costs linked with generating an extra unit of a product or service.

Average Cost

The overall expense of manufacturing split by the quantity of units made.

Rate of Return

The increase or decrease in value of an investment throughout a determined period, shown as a percent of the investment’s initial cost.

Natural Monopolies

A market situation where a single supplier, due to unique resources, technology, or economies of scale, can provide a product or service at a lower cost than any potential competitor.