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QUESTION 7 A stock price, currently $120, is modelled by means of a two-period recombining bino- mial tree with u = 1.25, d = 0.8. The stock does not pay dividends. The continuously compounded constant riskfree rate is assumed to be 5% per period. A derivative is written on this stock. It pays $130 if the stock price is not $120 at the end of the second period, and $0 otherwise. (a) Calculate the risk-neutral probability measure. [2 marks] (b) Use the risk-neutral probability measure to calculate the current price of the deriva- tive. [4 marks] (c) Explain why the real-world probability measure is irrelevant to the price of the deriva- tive. [1 mark] [Total: 7 marks]