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3. TERNARY MODEL (30 POINTS) Instead of the Binomial model developed in class, assume that now the stock price follows a ternary one-period model,

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3. TERNARY MODEL (30 POINTS) Instead of the Binomial model developed in class, assume that now the stock price follows a ternary one-period model, that is, at time 0 the stock price can go up by a factor u, down by a factor d, and stay somewhere in between with the factor m (u > 1>d, u > m> d). The positive probabilities of the stock going up, middle, and down are pu, Pm, Pd, respectively (probabilities of course sum up to one). The stock market is assumed to consist of the money market account paying interest rate r, the stock, and a call option. In general, what makes it impossible to price the option in such a model? Please provide a rigorous argument for your answer. 2. Consider a one-step binomial tree model with So = 50, u = 2, r = 1%. The actual probability is given by p=2/3, 9 = 1/3. (a) Write down the risk-neutral probabilities. (b) Evaluate the European call and put option prices struck at K = 50 at the end of the first time step.

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