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PRMIA Exam 8007 Topic 1 Question 52 Discussion

Actual exam question for PRMIA's Mathematical Foundations of Risk Measurement ? 2015 Edition exam
Question #: 52
Topic #: 1
[All Mathematical Foundations of Risk Measurement ? 2015 Edition Questions]

A 2-step binomial tree is used to value an American put option with strike 105, given that the underlying price is currently 100. At each step the underlying price can move up by 10 or down by 10 and the risk-neutral probability of an up move is 0.6. There are no dividends paid on the underlying and the continuously compounded risk free interest rate over each time step is 1%. What is the value of the option in this model?

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Suggested Answer: A

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