2. Imagine a simple economy that has only two possible states one year from now: boom or gloom, with probabilities of 0.8 and 0.2, respectively. The current price of Stock 1 is $80, and its two boom/gloom prices are $120 and $60 respectively. The current price of Stock 2 is $10.5, and its two boom/gloom prices are $20 and $5 respectively. A call option is written on each stock with exercise price of $90 and $16 respectively. A: B: C: What is the correct value of each call option? What is the value of each call if we use the expected return on the stock to discount the expected payoff? What is the correct expected return on each call? What is the relationship between the two expected returns? Please explain intuitively. Suppose you observe a market price of $12 for the call on Stock 1. Is there any arbitrage opportunity? How to take advantage of it, if any? How much is the profit? Re-do Part C by changing the exercise price of the call on Stock 1 from $90 to $50. D. E. (Please use continuous compounding throughout.) 2. Imagine a simple economy that has only two possible states one year from now: boom or gloom, with probabilities of 0.8 and 0.2, respectively. The current price of Stock 1 is $80, and its two boom/gloom prices are $120 and $60 respectively. The current price of Stock 2 is $10.5, and its two boom/gloom prices are $20 and $5 respectively. A call option is written on each stock with exercise price of $90 and $16 respectively. A: B: C: What is the correct value of each call option? What is the value of each call if we use the expected return on the stock to discount the expected payoff? What is the correct expected return on each call? What is the relationship between the two expected returns? Please explain intuitively. Suppose you observe a market price of $12 for the call on Stock 1. Is there any arbitrage opportunity? How to take advantage of it, if any? How much is the profit? Re-do Part C by changing the exercise price of the call on Stock 1 from $90 to $50. D. E. (Please use continuous compounding throughout.)