Binomial Tree

AAA

DEFINITION of 'Binomial Tree'

A graphical representation of possible intrinsic values that an option may take at different nodes or time periods. The value of the option depends on the underlying stock or bond, and the value of the option at any node depends on the probability that the price of the underlying asset will either decrease or increase at any given node.

INVESTOPEDIA EXPLAINS 'Binomial Tree'

Binomial trees are useful tools when pricing options and embedded options, but there is a fundamental flaw with the model. The problem lies in the possible values the underlying asset can take in one period time. In this model, the underlying asset can only be worth exactly one of two possible values, which is not realistic, as assets can be worth any number of values within any given range.

RELATED TERMS
  1. Algebraic Method

    A mathematical means of solving a pair of linear equations. Algebraic ...
  2. Functional Decomposition

    A method of business analysis that dissects a complex business ...
  3. Decision Tree

    A schematic tree-shaped diagram used to determine a course of ...
  4. Tree Diagram

    A diagram used in strategic decision making, valuation or probability ...
  5. Embedded Option

    A provision in a security that is an inseparable part of the ...
  6. European Option

    An option that can only be exercised at the end of its life, ...
Related Articles
  1. Breaking Down The Binomial Model To ...
    Options & Futures

    Breaking Down The Binomial Model To ...

  2. Find The Right Fit With Probability ...
    Fundamental Analysis

    Find The Right Fit With Probability ...

  3. The
    Options & Futures

    The "True" Cost Of Stock Options

  4. Getting To Know Business Models
    Entrepreneurship

    Getting To Know Business Models

comments powered by Disqus
Hot Definitions
  1. Accounts Payable - AP

    An accounting entry that represents an entity's obligation to pay off a short-term debt to its creditors. The accounts payable ...
  2. Ratio Analysis

    Quantitative analysis of information contained in a company’s financial statements. Ratio analysis is based on line items ...
  3. Days Payable Outstanding - DPO

    A company's average payable period. Calculated as: ending accounts payable / (cost of sales/number of days).
  4. Net Sales

    The amount of sales generated by a company after the deduction of returns, allowances for damaged or missing goods and any ...
  5. Over The Counter

    A security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, etc. The phrase "over-the-counter" ...
  6. Earnings Before Interest After Taxes - EBIAT

    A financial measure that is an indicator of a company's operating performance. EBIAT, which is equivalent to after-tax EBIT ...
Trading Center