_{^{Please answer (d)}}

(2) Suppose the price of a (non-dividend-paying) stock is restricted to the two-period binomial market shown below. (Notice that this is a multiplicative tree, with su - (7/2)80 and Sd = (1/2)80 on each subtree.) Suppose further that the money-market account doubles in each time period (in other words, 1 + R = 2). 7 2 1 (a) What is the risk-neutral probability of the up branch at each node? (b) Price a call with strike 5 which matures at the end of the second time period. (c) Suppose you wish to replicate this call, by a self-financing trading strategy using stock and money-market holdings. Specify the replicating portfolio at each node. (2) Suppose the price of a (non-dividend-paying) stock is restricted to the two-period binomial market shown below. (Notice that this is a multiplicative tree, with su - (7/2)80 and Sd = (1/2)80 on each subtree.) Suppose further that the money-market account doubles in each time period (in other words, 1 + R = 2). 7 2 1 (a) What is the risk-neutral probability of the up branch at each node? (b) Price a call with strike 5 which matures at the end of the second time period. (c) Suppose you wish to replicate this call, by a self-financing trading strategy using stock and money-market holdings. Specify the replicating portfolio at each node