2. Assume that the current price of spot gold is 1800. In the next two periods the

price of gold is expected to either go up by 5% or decline by 5% each period.

The risk-free cumulative rate over each period is 2% (the equivalent

continuous rate is lower at (ln1.02)).

1. What is the value of a European call option on gold which matures in one period with a strike price of 1800? What is the hedge ratio? What is the value of a put option with the same strike price?

b. What is the value of a call option on gold which matures in two periods with a striking price of 1800? What are the hedge ratios? What is the value of a put option with the same strike? Compare the values of the options with the option values obtained in a.