(30 points) Consider a two-period financial market with t=0,1,2 and two assets St=(Bt,St) : - A risk-free bond, B, with B0=1 and Bt=(1+r)t,r=0.5 - A risky asset, S=(St)t=0,1,2, with S0=1 and possible returns a=0 and b=1 (a) Draw a binomial tree for the possible values of (St)t=0,1,2 and state p. (b) Price the tunnel option at each time t=0,1,2, by finding v(t,St)=t(C), whose payoff at time t=2 is C=3,1,3,ifS2=4ifS2=2ifS2=1 (c) Hedge the above tunnel option by finding the hedging strategy t=(t(0),t(1)) for t=1,2. (30 points) Consider a two-period financial market with t=0,1,2 and two assets St=(Bt,St) : - A risk-free bond, B, with B0=1 and Bt=(1+r)t,r=0.5 - A risky asset, S=(St)t=0,1,2, with S0=1 and possible returns a=0 and b=1 (a) Draw a binomial tree for the possible values of (St)t=0,1,2 and state p. (b) Price the tunnel option at each time t=0,1,2, by finding v(t,St)=t(C), whose payoff at time t=2 is C=3,1,3,ifS2=4ifS2=2ifS2=1 (c) Hedge the above tunnel option by finding the hedging strategy t=(t(0),t(1)) for t=1,2