Consider a 1-year European call option on one share. The current stock price is $25 and expected volatility is 30%p.a. The strike price is $24 and the constant risk-free rate is 5% p.a. continuously compounded. The current price of the call is $4.50.

a) Using a two-period binomial model, what strategy should be used to lock in an arbitrage profit assuming the stock price decreases in the first period and then increases in the second period? b) Explain what synthetic position was created, its cost and how this relates to the arbitrage strategy.