Practice Question 23.1


Practice Question 23.1

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StephenMC
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1.The downside formula is 1/U; so, why does the answer start by saying

"The downside change is:" ... and then start with the upside formula [exp(sigma/sqrt(h))]. 

2. Where does the 85% come from?  100% - downside = upside?

[NEAS: The candidate asks about the first practice problem in "advanced option valuation, which derives the volatility from the up and down movements. The down movement is the reciprocal of the up movement here, so the formula uses a negative sign in the exponent. A factor of 0.85 is a return of -15%.]




Regards,

Stephen
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