CFA Level I · CFA Level I Exam · Valuing a Derivative Using a One-Period Binomial Model
A stock is priced at 40 and will be either 48 or 34 in one period. The risk-free rate is 4% for the period. A European put has an exercise price of 40. The hedge ratio of the put (change in put value per change in stock price) is closest to:
The put's hedge ratio is about -0.43. The put pays 0 if the stock rises to 48 and 6 if it falls to 34, so the payoff change is -6 against a stock change of 14. The negative sign shows puts move opposite to the stock.
- A-0.43Correct
- B-0.29
- C0.43
Explanation
Put payoffs are 0 in the up state and 6 in the down state. Hedge ratio = (0 - 6)/(48 - 34) = -6/14 = -0.43. The positive value ignores that puts lose value when the stock rises; -0.29 uses an incorrect spread.
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