1). The volatility of a non-dividend-paying stock whose price is $78, is 30%. The risk-free rate is 3% per annum (continuously compounded) for all maturities.

(a) What is the percentage up movement?

(b) What is the percentage down movement?

(c) What is the probability of an up movement in a risk-neutral world?

(d) What is the probability of a down movement in a risk-neutral world?

(e) What is the value of a four-month European call option with a strike price of $80 given by a two-step binomial tree?

(f) Draw the two-step binomial tree

2) Explain the principle of risk-neutral valuation