Q.5 The Financial Institution OMEGA Incorporated in the sunny State of California is implementing the latest risk valuation techniques. It employs a Binomial Option Model in order to achieve the Perfect Hedge and pay its obligations in the good, and the bad state of nature respectively. However, his CEO Dr. Ding-Dong suffered from a temporary lapse of memory and he forgot how to use this optimum risk hedging technique.

a. Employ a European Call option of 10 dollars, a multiplicative upward factor of 1.5, a multiplicative downward factor of 0.7, a probability of jump occurrence p= 0.5 for every state of nature happening, a stock price of $100, a striking price of $100, a risk-free rate = 4% and create the notion of the PERFECT HEDGE. b. What is the Optimum Hedge Ratio?

c. What is the intrinsic value of the Option in the good state and bad state respectively? d. What is the proper value that the European Call commands? Is it Overvalued or Undervalued? e. Do you like the Binomial Model, or you prefer to deal with the Continuous Option Models that we have learned in class? Carefully explain your answer.