The risk-neutral probabilities for an asset, with a current value equal to the present value of future payoffs are:
A)given by the probability of each state occurring.
B)given by the value of the underlying asset under good news and the risk free rate.
C)given by the value of the underlying asset under good news and bad news.
D)given by the value of the underlying asset under good news, bad news, and the risk free
Rate.
E)None of the above.

Question

Quizplus · Accepted Answer

Risk-neutral probabilities are calculated considering the value of the underlying asset in both good and bad states, as well as the risk-free rate, to discount these future payoffs back to their present value. This approach ensures that the expected return on the asset is equal to the risk-free rate, hence the term "risk-neutral."

The Risk-Neutral Probabilities for an Asset, with a Current Value