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QUESTION 13 Question 3.1 (10 marks) A stock price is currently $42. Its volatility is 20% p.a. . The risk-free interest rate is 10% p.a.

QUESTION 13

Question 3.1 (10 marks)

A stock price is currently $42. Its volatility is 20% p.a. . The risk-free interest rate is 10% p.a. with continuous compounding.
1. What is the value of a 2-year European put option with a strike price of $44, using a 2-step binomial tree? (8 marks)
2. Without doing any calculations, explain what would happen to the value of the option if the stock volatility increases. (2 marks)

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