Conditions for deterministic stock price path equity option
Explain the conditions for assuming a deterministic stock price path for an equity option.
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We have to impose several conditions upon the function r(t).• Forward rates must be positive, or here will be arbitrage opportunities.• Forward rates must be continuous (however this is commonsense rather than due to any financial argument).• Perhaps the curve must also be smooth.
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A stock whose value is now $44.75 is growing on average by 15 percent per annum. Its volatility is 22 percent. The interest rate is 4 percent. You need to value a call option along with a strike of $45, expiring in two months’ time. So, what can you do?
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