Q6) Lets walk through how we would price a put in a two-state pricing model. Suppose the current price of the stock is $83. The stock pays no dividends and will be worth $90 if the economy booms and $80 if the economy stalls one year from now. Suppose also that the risk-free rate is 3% per year.

(6a) Suppose we have a (European) put with time to expiration of 1 year, and a strike price of $85. What is the price of this put option?

(6b) What is the price to the (European) call with a 1-year expiration and a strike price of $85 on the same stock?

(6c) Suppose the call option were mispriced at $2.50 (as compared to your answer in part (b)). Describe the holdings (remember to include the correct proportions) in the arbitrage strategy and the total profit ($) in one year resulting from your strategy.