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CA Final · Advanced Financial Management · Derivatives Analysis and Valuation

The share of Narmada Autos is priced at ₹500. After one period it will be either ₹600 or ₹400. The one-period risk-free rate is 8%. What is the value of a European put with a strike price of ₹520 under the one-period binomial model?

The put is worth ₹33.33. The risk-neutral probability of the down move is 0.30, and the put pays ₹120 only in that state. The expected payoff is ₹36, which is discounted at 8% for one period to give ₹33.33.

  1. A₹33.33Correct
  2. B₹36.00
  3. C₹55.56
  4. D₹77.78

Explanation

Risk-neutral p(up) = (1.08×500 − 400)/200 = 0.70, so p(down) = 0.30. Put payoffs are ₹0 (up) and ₹120 (down). Put = 0.30×120/1.08 = 36/1.08 = ₹33.33. ₹36.00 omits discounting, and ₹77.78 wrongly uses p(up) = 0.70 on the down payoff.

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