Option Binomial always, checked, presented, material

hw0799

So, the Schweser material says that you calculate a down move at 1/U while in the CFAI EOC they always tell you that the up is 20% and down is say, 15%. In the few cases that I checked the CFAI material down never equaled 1/U.

Does anyone know how this will be presented on the exam?

SFoyil

I'm not sure if you are talking about the value of the move or the probability of it. But they would both have to be calculated.

busterbluth

Value. for example Schweser in their book will give you the value of up at 1.33 they then say you calculate the value of down as 1/1.33.

In CFAI they give you value of up and value of down in terms of percent.

I can solve the CFAI fine but what has me confused is why Schweser does it this way and which should we expect on the exam

luda002

Is the CFAI automatically giving you the risk neutral probabilities? I didn't use the CFAI text to learn this material.



Edited 1 time(s). Last edit at Wednesday, May 18, 2011 at 02:19PM by KSTHANE.

ppls

from what i know, its just about how you decide to model volatility

a common way is to do down=1/up

CFAI could be using some other model and giving you the up and the down, so just use what they give you

lucasg85

I know that Schweser uses D = 1/U. I think that's incorrect.
On the exam, you'll likely be given the size of the up and down movements just like the CFAI text does.

In real life, size of up and down moves are calculated using permutation.



Edited 1 time(s). Last edit at Wednesday, May 18, 2011 at 03:53PM by Iginla2010.

SeanWest

So how do you calculate the risk neutral probabilities if they give you the size of the up move as a percent? Let's say the size of an up move is 40% for example? It doesn't work to use the formula I have which is 1+Rf-D/U - D

yalo

^ are you talking about the "size of movements" or the probabilities (Pi up, Pi Down). Because the formula you mentioned above is used to calculate the Pi

chandsingh

I want to know how you calculate Pi when the size of the movements isn't given in decimal form (like 1.33), and is instead given in percentage form (like 15%).

needhelp1700

For example, if they give you the size of an up move as 1.33 then the formula would come out (let's say risk free rate is 5%)

1+.05-(1/1.33) / 1.33-.75 = .51 So the risk neutral probability of an up move (pi) is 51%

If they give the movement size as a percent, the above formula doesn't work. So how do you do it when they give the movement size as a percent instead.