'Pricing and Hedging' 12.20.

Consider a European call option on a non-dividend-paying stock where the stock price is

$40, the strike price is $40, the risk-free rate is 4% per annum, the volatility is 30% per

annum, and the time to maturity is 6 months.

(a) Calculate u, d, and p for a two-step tree.

(b) Value the option using a two-step tree.

(c) Verify that DerivaGem gives the same answer.

(d) Use DerivaGem to value the option with 5, 50, 100, and 500 time steps.