In the one-period BOPM the current stock price S = 90 , U =1.1 99 and D =0.9. 81 A one-period European call option (on a non-dividend paying stock) has . The risk-free interest rate is =2% per period (simple interest).

a). Calculate the call premium, the hedge-ratio, the value of the hedged portfolio (if the stock price either rises or falls) and explain why the hedge-portfolio is risk-free.

If you set up the hedge portfolio using you own funds, explain why the hedge-portfolio earns the risk-free rate of interest.

b). Explain and show the steps required to make a risk-free arbitrage profit if all market makers are quoting a price for the call of Cq =5.0.