Financial Risk Manager Part 1
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A firm, which had previously relied exclusively on the Black-Scholes-Merton (BSM) model for the valuation of options, has now opted to incorporate the binomial tree option pricing model into its valuation toolkit. An analyst at the firm is tasked with examining the unique characteristics of these two models in order to evaluate and contrast their parameters and assumptions. In making this comparison between the BSM model and the binomial tree model, which of the following statements is accurate?
A firm, which had previously relied exclusively on the Black-Scholes-Merton (BSM) model for the valuation of options, has now opted to incorporate the binomial tree option pricing model into its valuation toolkit. An analyst at the firm is tasked with examining the unique characteristics of these two models in order to evaluate and contrast their parameters and assumptions. In making this comparison between the BSM model and the binomial tree model, which of the following statements is accurate?
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A
1 The BSM model uses an underlying asset's implied volatility as an input but the binomial tree approach uses its historical volatility.
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B
The binomial tree approach, but not the BSM model, assumes that the expected return from the underlying asset is the risk-free rate of interest.
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