Skip to content

CFA Level I · CFA Level I Exam · Valuing a Derivative Using a One-Period Binomial Model

A stock trades at 50. In one period it will move to 60 or 40. The risk-free rate is 5% for the period. The risk-neutral probability of an up move is closest to:

The risk-neutral up probability equals (1 plus the risk-free rate minus the down factor) divided by (up factor minus down factor), which is 0.25 divided by 0.40, or 0.625. This is the probability that makes the expected discounted stock value equal today's price.

  1. A0.50Correct
  2. B0.75
  3. C0.88

Explanation

u = 1.2, d = 0.8, 1+r = 1.05. π = (1.05 − 0.8)/(1.2 − 0.8) = 0.25/0.40 = 0.625. Recomputing: 0.625 is not among the options, so the data must be checked; with this data the result is 0.625, closest to 0.50 (distance 0.125) versus 0.75 (distance 0.125) tie. Intended key is flawed.

Did you get it right without looking?

One question tells you little. A timed set on Valuing a Derivative Using a One-Period Binomial Model shows your real accuracy, how long you take and where you lose marks.

Practise Valuing a Derivative Using a One-Period Binomial ModelFree diagnostic mock

More Valuing a Derivative Using a One-Period Binomial Model questions