A tree is constructed to value an option on an index which is currently worth 100 and has a volatility of 25%.The index provides a dividend yield of 2%.Another tree is constructed to value an option on a non-dividend-paying stock which is currently worth 100 and has a volatility of 25%.Which of the following are true?
A) The parameters p and u are the same for both trees
B) The parameter p is the same for both trees but u is not
C) The parameter u is the same for both trees but p is not
D) None of the above

Question

Quizplus · Accepted Answer

The formula for u is the same in the two cases so that the values of the index on its tree are the same as the values of the stock on its tree.However,in the formula for p,r is replaced by r−q.

A Tree Is Constructed to Value an Option on an Index