Black-Scholes-Merton model:

Using the information given where the spot price is $26 and strike price is $28, risk-free rate of return is 6% per annum with continuous compounding and the fact that the volatility of the share price is 18%, answer following questions:

a.What is the price of an eight-month European call?

b.What is the price of an eight-month American call?

c.What is the price of an eight-month European put?

d.How would your result from k. change if a dividend of $1 is expected in three months? How would your result from k. change if a dividend of $1 is expected in ten months?

Note for calculations with the BSM model: Keep four decimal points for d1 and d2. Use the Table for N(x) with interpolation in calculating N(d1) and N(d2).

Finally,

e.Compare the results you obtained for the prices of European puts and calls using binomial trees and Black-Scholes-Merton model. How large are the differences when expressed as a percentage of the spot price of the share? Provide a possible explanation for these differences.