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Consider a 3-month put option. Suppose that the underlying stock price is $25, the strike $26, the interest rate is 5% p.a., stock volatility

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Consider a 3-month put option. Suppose that the underlying stock price is $25, the strike $26, the interest rate is 5% p.a., stock volatility is 6% per month. Use the same data to answer questions a) h). Given: So a) What is the level of annual volatility (compute)? $25 X $26 r 5% Volatility 6% =SQRT (12) *6%= 20.785% b) Define in your own words implied volatility. Answer: Implied volatility is c) How would you compute implied volatility? Explain (no need to compute). d) What is the probability of stock price going down (Note: use annual volatility, number of steps in a tree is N=3) e) Build the binomial tree for the underlying asset (stock). Note: the tree nodes can be edited. Show computations for first up and first down nodes.

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