Each of the following questions should be answered by building a 15-period binomial model whose parameters should be calibrated to a Black-Scholes geometric Brownian motion model with: T =.25 years, S0 =100, r=2%, =30% and a dividend yield of c=1%. Your binomial model should use a value of u = 1.0395 and d = 1/u = 0.96201. (This has been rounded to four decimal places but you should not do any rounding in your spreadsheet calculations.)

1.Compute the price of an American call option with strike K = 110 and maturity T = .25 years.

2.Compute the price of an American put option with strike K = 110 and maturity T = .25 years.

3. Is it ever optimal to early exercise the put option of Question 2?

4. If your answer to Question 3 is Yes, when is the earliest period at which it might be optimal to early exercise? (If your answer to Question 3 is No, then you should submit an answer of 15 since exercising after 15 periods is not an early exercise.)

5. Do the call and put option prices of Questions 1 and 2 satisfy put-call parity?

6. Identify four conditions under which an arbitrage opportunity will exist with reference to the option price you computed in (1) above and briefly explain how such an opportunity can be exploited