Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

(Hop HipldF0AV) #1

Δ = Number of shares in replicating portfolio.


B= Dollars of borrowing in replicating portfolio.


TheobjectiveistocombineΔsharesofstockandBdollarsof
borrowingto replicate thecash flowsfrom thecallwith a
strikepriceof50.Thiscanbedoneiteratively,startingwith
the last period and working back through the binomial tree.


Step 1:Start with the end nodes and work backwards:


Thus,ifthestockpriceis$70att=1,borrowing$45and
buyingoneshareofthestockwillgivethesamecashflowsas
buyingthecall.Thevalueofthecallatt=1,ifthestockprice
is $70, is:


Considering the other leg of the binomial tree att= 1,

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