In the binomial model, the symbols u and d represent which concept?

• A. Initial stock price
• B. Probability of an up move
• C. Volatility of the stock
• D. Up and down movement multipliers for the stock price

Answer: (D)

In the binomial model, u and d are the up and down multipliers applied to the current price to obtain future prices. If the current price is S, the next possible prices are Su and Sd. They encode how far the price can move in one step, not the price level itself, not a probability, and not the volatility by themselves (though larger gaps between u and d reflect greater volatility). Together with the risk-free rate, these multipliers determine the risk-neutral probabilities and the value of derivatives on the stock.