Use the information for the question(s)below.
The current price of KD Industries stock is $20.In the next year the stock price will either go up by 20% or go down by 20%.KD pays no dividends.The one-year risk-free rate is 5% and will remain constant.
-The risk-neutral probability of a down state for KD Industries is closest to:
A)37.5%.
B)62.5%.
C)40.0%.
D)60.0%.

Question

Quizplus · Accepted Answer

The risk-neutral probability of a down state can be calculated using the formula: p = (1 + r - d) / (u - d), where r is the risk-free rate, u is the up factor, and d is the down factor. Here, u = 1.2, d = 0.8, and r = 0.05. Plugging in these values gives p = (1.05 - 0.8) / (1.2 - 0.8) = 0.375 or 37.5%.

Use the Information for the Question(s)below