In a one-period binomial model, assume that the current stock price is $100, and that it will rise to $110 or fall to $90 after one month. If the risk-neutral probability of the stock going up or down is equal, what is the one-month risk-free interest rate in continuously-compounded and annualized terms?
A) 0%
B) 1%
C) 2%
D) 3%

Question

Quizplus · Accepted Answer

In a risk-neutral world, the expected stock price should equal the current stock price compounded at the risk-free rate. With equal probabilities, the expected price is $100, which implies a 0% risk-free rate.

In a One-Period Binomial Model, Assume That the Current Stock