CFAI Mock 2012 Q9 Morning Session

In this question, inspite of having the down move for stock, they have calculated from the up move. I thought this should only be calculated if the down move is not given. Why is it given in the first place? Just to distract people?

Well, they have used it… Its a 15 % up move and a 10% down move… So U =1.15 and D= .09

Holy cow! so when they say down move means deduct rather than adding the percentage. May I dare to ask you why is that? Should the next period up move always be greater than the current stock price and down move lesser? Is it possible to have the next move both in up or down direction? Probably I am thinking too much but this answer will help me understand better.

in response to your question: i guess when you see up, it means 1 + up%. but when it says down, you do 1 - down%. why? that’s just how it is. yes, a binomial tree “up” state means a larger value, and likewise, a “down” state means a smaller value. since it’s a “binomial” tree, events result in a binary situation. so it EITHER goes up OR down, not both. yes, you are indeed thinking too much.

but on another note: shouldn’t we be actually CALCULATING what the down move is? isn’t d = 1/u? so, if u is 1.15, shouldn’t d = 1/1.15 = 0.8696, instead of 0.9? and if you use that figure, your risk neutral up and down would be slightly different! i guess this is what you do when you’re actually GIVEN the u and d in the question. you just simply use them!