A branching tree for the binomial model:
A)Should captures all possible futures paths for the asset.
B)Has a move down followed by a move up on a subsequent branch to end at the same
Value as the reverse path.
C)Has a move down followed by a move up on a subsequent branch to end at a lower
Value than a move up then a move down.
D)Both A and C.
E)Both A and B.

Question

Quizplus · Accepted Answer

A branching tree for the binomial model should capture all possible futures paths for the asset (A), and it should have a move down followed by a move up on a subsequent branch to end at the same value as the reverse path (B), which is known as the principle of no-arbitrage. However, it is not necessary for a move down followed by a move up to end at a lower value than a move up then a move down (C). Therefore, the best choice is E, which includes both A and B but not C.

A Branching Tree for the Binomial Model