Please explain how to calculate the prob of price limits of FP1 and FP2 in the following Multiple Step Binomial Model problem
Q) A stock is currently priced at Rs50. It is known that in the first 6 months of current year from now prices will either rise by 20% or go down by 20%, further in the later half of the year prices may again go up by 20% or go down by 20% in the second step. Suppose risk free interest rate is 5% continuous compounding and strike rate is Rs52. Calculate value of European Put Option.
( my doubt is only regarding the computation of probabilities of price limits for each step--in the exercise it is shown as FP1=0.50 and FP2=0.50. However using the formula: Probability of lower price limit = (u-f)/(u-d) and Probability of higher price limit = f-d/u-d the probabilities are different that what is shown in the exercise i.e 0.50.)
Regards John John
CAclubindia
