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Binomial tree and option pricing. A stock's price S is $100. After three months, it either goes up and gets multiplied by the up factor
Binomial tree and option pricing. A stock's price S is $100. After three months, it either goes up and gets multiplied by the up factor U = 1.10, or it goes down and gets multiplied by the down factor D= 0.90. Options mature after T = 0.25 years and have a strike price K = 100. The continuously com- pounded interest rate is 2% for all maturities. Answer the following questions. (a) Calculate the value of the call option using no arbitrage valuation. (b) Demonstrate how you could make arbitrage profits when a trader quotes a call price of $7. ) Calculate the value of the call option using risk-neutral valuation. (d) Calculate the value of the put option using no arbitrage valuation. (e) )Demonstrate how you could make arbitrage profits when a trader quotes a put price of $3. (f) Calculate the value of the put option using risk-neutral valuation. (g) Show the values of call and put options in (c) and (f) satisfy the put-call parity
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