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a. Consider a non-dividend paying stock with current price $30. In one period the price will either rise by 40% or fall by 20%. The

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a. Consider a non-dividend paying stock with current price $30. In one period the price will either rise by 40% or fall by 20%. The one-period risk free rate is 5%. i. Derive the price of a European put option with strike price $32 and one period to maturity. Explain the steps in your pricing analysis as you perform them. (15 marks) ii. State and explain the put-call parity condition. Use put-call par- ity to compute the price of a one-period call option with the same strike price is the put option above. (10 marks) iii. Consider the call option from part (ii). If the stock was to pay a cash dividend at some point during the next period, would you expect the call option price to rise or fall? Give some intuition to explain your answer. [Write no more than 8 sentences in your answer.] (10 marks) iv. Give a brief assessment of how reasonable you believe the assumptions of the binomial approach to option pricing to be. [Write no more than 10 sentences in your answer.]

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