Can someone summarize the exam points to remember regarding the binomial model? I know we use it for options and bonds w/options. However, when used to value options alone we calculate the probabilities associated with up and down moves but when we use this with bonds we take a 50% up 50% down, correct?
Yes For options: u: (1+r - d) / u -d d: 1-u
for stock option, pie(u) = (1+rf - D) / (U-D), pie(d) = 1- pie(u). for bond option, 50% for both up and down. both of them are under theory of “risk neutral probability”
For bonds AND for rates when calculating caplets and floorlets.
hmmmmmmm i really need to go over this one more time …good heads up guys