1. Consider a one period binomial market model where there is a risk-free asset offering r = 1/4 per period and a risky asset (stock) with So= 4, S1 (H) = 8, S1 (T) = 2. (a) Find the price at time zero of a European put option with exercise date T = 1 and strike price K = 5. Find also the replicating portfolio (at time zero) for this put option. Recall that the payoff of a European put option at time one is given by V = max(K - S1, 0}.

(b) Suppose that the put is traded at $1.5 at t=0 in this market. Is there an arbitrage in this market? If so, describe an arbitrage strategy.