Consider a two-step binomial model (left(S_{k} ight)_{k=0,1,2}) with interest rate (r=0 %) and risk-neutral probabilities (left(p^{*}, q^{*}

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Consider a two-step binomial model \(\left(S_{k}\right)_{k=0,1,2}\) with interest rate \(r=0 \%\) and risk-neutral probabilities \(\left(p^{*}, q^{*}\right)\) :

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a) At time \(t=1\), would you exercise the American put option with strike price \(K=1.25\) if \(S_{1}=1.2\) ? If \(S_{1}=0.9\) ?

b) What would be your investment allocation at time \(t=0\) ?

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