QUESTION THREE

a) A stock is currently traded at $100 and in four months its price will be . A derivative written

on this stock pays off [

(1/3)

] in four months. The risk-free rate is 10% p.a., =

(1.1 + /100) , and = 1/, where reg = 8

Answer the following questions using a one-period binomial model (show all the details of

your calculation, explain intermediate results, and show your results with 4 decimal places):

i. Calculate the value of .

(10 marks)

ii. Using the value of obtained in (i) above, calculate the current value of the derivative.

(5 marks)