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:

Ten-Year Treasury Note

A government debt security issued by the U.S. Treasury with a ten-year maturity, which pays interest to the holder every six months.

Cash Equivalent

Short-term, highly liquid investments that are easily convertible to known amounts of cash and close to their maturity.

Certificate of Deposit

A time deposit at a bank or financial institution that offers a fixed interest rate over a specified period.

Capital Acquisitions Ratio

A measure of a company’s ability to finance its investment in fixed assets through net income, indicating how much of the company’s capital is being acquired through profits.