So is there an accepted way to come up with the down move factor for binomial option valuation? The way it was done on the CFAI mock exam is a way I have never seen before.
If they tell me that a stock can drop 20% over two periods I would just take the current price and multiply by .8 twice. Absent information about how much the stock is going to drop I have seen people take the up move factor that is given and take the inverse. So a 15% up move would mean a 1/1.15 down move so that you are taking .87 by the price to get how much it would be on the way down.
The way they do it on the mock exam is to take the negative down move of 20% and basically say it’s the inverse of 1.2 for a .833 down move factor.
I guess that is the way I will do it on the exam; but that is not how they show you how to do it in Schweser. Perhaps Schweser is giving too simplistic of examples in their readings.