A stock is priced at $515 and the stock return volatility is 0.5. A dividend yield of 2% will be paid at the end of the current month (no other dividend payment after that). The continuously compounded risk-free rate, r_c, is 0.04. Use a two-period binomial option pricing model to price a 2-month European and a 2-month American call with an exercise price of $525. Each period in the binomial tree is one month.

a) Use the equations below to compute u, d, and p. Show your work. (1.5 points)

b) Construct the binomial tree for the stock and insert the corresponding value for the stock at each node on the tree. You must show your calculations for the value at each node. (2.5 points)

c) Construct a binomial tree for the European call option and insert the corresponding value of the option at each node on the tree. You must show your calculations for the value of the option at each node. Calculate the value for the European call option. (3 points)

d) Construct a separate binomial tree for the stock and the American call option and insert the corresponding value of the option at each node on the tree. You must show your calculations for the value of the option at each node. Calculate the value for the American call option. (3 points)

1 eTcXT/ -d u-d