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

A stock trades at 80. In a one-period binomial model the up factor is 1.25 and the down factor is 0.80. The stock prices at the end of the period are closest to:

Multiplying the current price of 80 by the up factor 1.25 gives 100, and multiplying by the down factor 0.80 gives 64. The two possible end-of-period prices are therefore 100 and 64.

  1. AUp 96 and down 64
  2. BUp 100 and down 64Correct
  3. CUp 100 and down 60

Explanation

Up price = 80 × 1.25 = 100. Down price = 80 × 0.80 = 64. Option A applies a 1.20 up factor, and option C applies a 0.75 down factor, so both are wrong.

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