Question
Question 3 Assume a two-period call option with K = $100, the current stock price is S0 = $110 and the stock can increase or
Question 3 Assume a two-period call option with K = $100, the current stock price is S0 = $110 and the stock can increase or decrease in price by 10% per period. The risk-free rate is r = 5% (simple rate, per period), R = 1 + r and the riskneutral probability of an up move in the stock price is q = (R D) / (U D). a) Use the BOPM tree to show that the fair price for the call is around C0 = $20. b) Explain the meaning of risk-neutral valuation (RNV) in the context of the BOPM. c) If the quoted price of the call is Cq=$22.0, explain how you can make a riskless arbitrage profit.
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