Morgan Stanley stock is currently traded at $101.00 per share on the market. It is expected to either grow to $114.00 or fall to $88.00 in the next three months. The risk-free interest rate is 3.25% pa. You are asked to value the following two European options written on the Morgan Stanley stock maturing in 3 months:

• A call option with a strike price of $103.00
• A put option with a strike price of $99.00

a) What should be the price of the call option?

b) What should be the price of the put option?

c) Discuss the risk-neutral valuation principle in option pricing. Explain why this valuation principle can be and is applied while both the stock and the option are risky securities?