Investors are often attracted to alternative investments when seeking greater diversification and/or higher expected returns in exchange for what are often longer-term, illiquid investments in less efficient markets. The features of these investments necessitate specific skills and information to evaluate their performance and include unique factors investors must consider if adding them to a portfolio.…
The binomial model builds on a simple idea: Over a given period of time, the asset’s price will either go up (u) to S 1 u > S 0 or go down (d) to S 1 d < S 0. We do not need to know the future price in advance, because it is determined by the outcome of a random variable. The movement from S 0 to either S 1 u or S 1 d can…
Combining the synthetic asset with the put–call parity relationship—so, substituting the present value of F 0(T) for S 0 in Equation 1—we have what is referred to as put–call forward parity.
Forward commitment replication was shown in earlier lessons to involve borrowing at the risk-free rate to purchase the underlying in the case of a long position or selling the underlying short and lending the proceeds at the risk-free rate for a short position. We also showed that a long underlying position combined with a short…
Value of the Underlying Exercise Price
