Bonus Problem 2 (Optional, 25 marks)

The current price of a continuous dividend paying asset is $60. The price movement of this asset in the coming 6 months is simulated by 2-period forward tree model. It is given that:

The annual dividend yield rate of the asset is 3%.

The volatility of the asset is 24%.

The annual riskfree interest rate is 2%.

(a) Alternatively, one may model the price movement of the asset using CRR model. Explain briefly why the forward tree model is more suitable in this scenario.

(b) We consider a 6-month chooser options which the holder can decide whether the option is European call option or European put option after 3 months (i.e. If the holder declares the option to be call (resp. put)option after 3 months, then the terminal payoff of the chooser option at maturity date is max( , 0) (resp. max( , 0)). It is given that the strike price of the chooser option is $55. Calculate the current price of the chooser option using risk neutral valuation principle.