Skip to content

CFA Level I · CFA Level I Exam · Statistical Distributions for Financial Asset Prices and Returns

A stock priced at 80 follows a two-period binomial tree. Each period it rises by a factor u = 1.10 or falls by a factor d = 0.90 (the up probability is 0.5 and moves are independent). The expected stock price after two periods is closest to:

The expected price is about 80.00. Terminal prices of 96.80, 79.20 and 64.80 have probabilities 0.25, 0.50 and 0.25, giving 24.20 + 39.60 + 16.20. Equivalently, each period's expected growth factor is 1.00, so the expectation stays at 80.

  1. A77.60
  2. B80.00Correct
  3. C88.00

Explanation

Terminal prices: 80×1.21 = 96.80 (p 0.25), 80×0.99 = 79.20 (p 0.50), 80×0.81 = 64.80 (p 0.25). Expected = 24.20 + 39.60 + 16.20 = 80.00. Per period the factor is 0.5×1.10 + 0.5×0.90 = 1.00. The 88.00 figure ignores the down moves.

Did you get it right without looking?

One question tells you little. A timed set on Statistical Distributions for Financial Asset Prices and Returns shows your real accuracy, how long you take and where you lose marks.

Practise Statistical Distributions for Financial Asset Prices and ReturnsFree diagnostic mock

More Statistical Distributions for Financial Asset Prices and Returns questions