Question

This is relating to a Risk-Neutral Binomial Tree. I was wondering on how do you get those values in the stuffs in red circle? (Using the formula given)

The Picture is basically the tree with the solution, but I'm trying to find out how they computed or use the formula to get those values

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Using the formula 1 = [(1+r1-d)/(u - d)], the tree diagram for the risk neutral probabilities derived from the returns to investing in the market is: Tuz.70 s1.20 a=2/3 $1.107 $1.00 1-1=13 -To=.30_$1.05 $1.05 TLF.65 $0.95 1-TOF 25._$0.90

Answer 1

The formula mentioned above is used to calculate the probability of an up-move or a down-move in the binomial tree. I have attached a screenshot to explain the formula with an example.

tłu = 1 +ht a Probability of an -D D. U- up-more! Usually quien Rf - Risk free rate. D- Down-more factor. u - apmore factor. Also D = 1 и. Example Given :- Rf = 7% U = 1,33. :: Dybo 20.75 Using the probability formula, Tu = IHRE-D = 1+0.07 20.75 -0.55 u-D 1.33 -0.75

TD= -0.55-0.45 tu=55.1. and TiD = 45.1.
I have tried to explain the formula with the help of an example. Let me know if you know the up-move factor and risk-free rate value of the above-mentioned sum and I'll be happy to solve it. Let me know in case of any doubt.