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A European binary ( or Digital) option pays $5 if stock ends above $56 after 3 months and nothing otherwise. The following 3-period binomial tree
A European binary ( or Digital) option pays $5 if stock ends above $56 after 3 months and nothing otherwise. The following 3-period binomial tree represents the MONTHLY stock price movements:
Assuming continuously compounded interest rate of r=3% and no dividends, find the REPLICATING PORTFOLIOS for each date if the stock prices moves according to
S(0) = 60 --> S(1) = 63.60 ---> S(2) = 61.06 ---> S(3) = 58.61
Verify that your replicating strategy is self-financing at each step.
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