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4. You are asked to price some options on ABC's stock. ABC's stock price can go up by 15% every year, or down by 5%.
4. You are asked to price some options on ABC's stock. ABC's stock price can go up by 15% every year, or down by 5%. Both outcomes are equally likely. The stock will not pay dividends over the next two years. The risk free interest rate is 3% per year for the next two years, and the current stock price of ABC is $100. (a) Find the risk neutral probability. (b) Draw the binomial trees for both the stock and an European Call option on ABC maturing in 2 years with strike $100. Use the risk neutral probabilities to compute the value of the call option at each node of the binomial tree. () Describe the strategy to replicate the payoff of the call using the stock and the risk-free bond. Give the positions of the replicating portfolio at each node of the binomial tree. (d) What is the price of an American option with the same charac- teristics
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