Question
A stock is currently selling at $100, with a 75% chance of increasing by 25% and a 25% chance of decreasing by 20% each year.
A stock is currently selling at $100, with a 75% chance of increasing by 25% and a 25% chance of decreasing by 20% each year. The risk-free interest rate is 5% per year (withannualcompounding). Assume that the stock will not pay any dividend for the next two years. Consider a put option on this stock, with an exercise price of $105 and two years to maturity. Use a binomial model with two time periods - year one and year two.
a. What is the value of the put if it isEuropean?
b. What is the value of the put if it isAmerican?
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