Question

1. An European put written on shares has a strike price of $26 and expires in four time steps. Using CRR notation, the underlying share prices are calculated using S = $25, u = 1.2, and d = 1/u. The return on a bank investment over each time step is R = 1.05.

a) Calculate all state prices at the put's expiry. That is, calculate all (4, j) for j = 0, 1, 2, 3, 4.

b) Use the state prices (4, j) to calculate the premium of the European put.