ACTEX 9.1 (Black/Scholes)

[AG]

Can somebody explain why this problem couldn't be solved by creating a price tree for a three-month period and calculate the discounted value of the option?

[flora77]

The question states all Black Scholes assumptions are in force

[asdfasdf]

I think theoritically the difference is that the Black Scholes formula assumes the price is changing continuosly, like Flora said the question mentions black scholes so that I think implies you have to use it, also the question mentions values of the Normal distribution which is a clue, (but some exam questions show normal distribution values even though you can use put call parity to solve)

[AG]

Yes, I was tired and missed all the obvious signs. Obviously I should have used B/S. Question was really why wouldn't another method work?

[Kenny]

Originally Posted by AG

Yes, I was tired and missed all the obvious signs. Obviously I should have used B/S. Question was really why wouldn't another method work?

A binomial model would be inappropriate bc the BS assumption of continuous compunding. The binomial model is designed to have node at each point in time. Similar to the relationship between effective and modified duration, the binomial model -> BS as y -> 0 (where y is the delta between points in time).