Homework Soursea If in a twostate model a stock can take a price of 176 or
a. If, in a two-state model, a stock can take a price of 176 or 132, what would be the hedge ratio for each of the following prices: $176, $170, $160, $132? (Leave no cells blank - be certain to enter \"0\" wherever required. Round your answers to 2 decimal places.)
b. What do you conclude about the hedge ratio as the option becomes progressively more in the money?
| X | Hedge Ratio | |
| $ | 176 | |
| $ | 170 | |
| $ | 160 | |
| $ | 132 | |
Solution
a). H = (Cu - Cd) / (uS0 - dS0)
uS0 - dS0 = $176 - $132 = $44
b). As we can see, as the option becomes progressively more in money, its hedge ratio increases to a maximum of 1.0. Hence, Option \"A\" is correct.
| X | Cu - Cd | Hedge Ratio |
| $176 | 0 - 0 = 0 | 0/44 = 0.00 |
| $170 | 6 - 0 = 6 | 6/44 = 0.14 |
| $160 | 16 - 0 = 16 | 16/44 = 0.36 |
| $132 | 44 - 0 = 44 | 44/44= 1.00 |
