INDEPENDENT WORK -- FIND PROBABILITIES ON THE BINOMIAL TREE (write your name here year 0 year1 year 2 Pb $1.20 $1.10 Pa $1 $1.05 Pc $0.95 $0.90 Above are possible paths of $1 investment in the market index. You can see that the value of investment can increase or decrease, in binomial fashion. Assume 5% annual risk-free rate and that there is no arbitrage. 1. Can you estimate the probabilities Pa, Pb, and Pc on this tree? For example, check that Pa= 67 2. At each point, think if we want to exercise a call option with a strike price K=1.10 (extra credit), can you value a call option on the market portfolio with K=1.10 and maturity T=2? INDEPENDENT WORK -- FIND PROBABILITIES ON THE BINOMIAL TREE (write your name here year 0 year1 year 2 Pb $1.20 $1.10 Pa $1 $1.05 Pc $0.95 $0.90 Above are possible paths of $1 investment in the market index. You can see that the value of investment can increase or decrease, in binomial fashion. Assume 5% annual risk-free rate and that there is no arbitrage. 1. Can you estimate the probabilities Pa, Pb, and Pc on this tree? For example, check that Pa= 67 2. At each point, think if we want to exercise a call option with a strike price K=1.10 (extra credit), can you value a call option on the market portfolio with K=1.10 and maturity T=2