6.2

Use the diagram below for problems 6.1-6.4. Sis a stock with multiperiod binomial tree shown above. The following hold: (1) The stock pays dividends continuously at a rate proportional to its price. The dividend yield is 4% (ii) Each step in the tree is of one year (iii) The risk free interest rate is 5% compounded contimously. 271 . 108.9 99 ud d 89.1 81 dd 72.9 6.1. You wish to price a year 89-strike European call on this stock. You are going to use a replicating portfolio to price the option. Then: (b) B=? (c) Cor? (d) How would your answers change if the underlying asset were purchased on a futures exchange? 6.2. Suppose that the market price of the call from #6.1(c) is 4.93. Is there an arbitrage opportunity? If not, explain why. If so, construct a portfolio with such an opportunity. (You should use work from #6.1!) Use the diagram below for problems 6.1-6.4. Sis a stock with multiperiod binomial tree shown above. The following hold: (1) The stock pays dividends continuously at a rate proportional to its price. The dividend yield is 4% (ii) Each step in the tree is of one year (iii) The risk free interest rate is 5% compounded contimously. 271 . 108.9 99 ud d 89.1 81 dd 72.9 6.1. You wish to price a year 89-strike European call on this stock. You are going to use a replicating portfolio to price the option. Then: (b) B=? (c) Cor? (d) How would your answers change if the underlying asset were purchased on a futures exchange? 6.2. Suppose that the market price of the call from #6.1(c) is 4.93. Is there an arbitrage opportunity? If not, explain why. If so, construct a portfolio with such an opportunity. (You should use work from #6.1!)