Consider a Binomial World in Which the Current Stock Price

question 22

Multiple Choice

Consider a binomial world in which the current stock price of 80 can either go up by 10 percent or down by 8 percent.The risk-free rate is 4 percent.Assume a one-period world.Answer questions 12 through 15 about a call with an exercise price of 80.
-What is the hedge ratio?

• A)0.429
• B)0.714
• C)0.571
• D)0.823
• E)none of the above

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Definitions:

Net Benefits

The total positive effects or gains from a decision or action minus any negative effects or costs associated with it.

Prospect Theory

A behavioral economics theory of preferences having three main features: (1) people evaluate options on the basis of whether they generate gains or losses relative to the status quo; (2) gains are subject to diminishing marginal utility, while losses are subject to diminishing marginal disutility; and (3) people are prone to loss aversion.

Salary

A form of payment from an employer to an employee, which may be specified in an employment contract.

Loss Averse

The behavioral tendency of individuals to prefer avoiding losses over acquiring equivalent gains, highlighting the emotional impact of loss.