QUESTION THREE This question concerns the two-step binomial tree method of pricing Options. You have the following information on a European Put Option: Expiry: 2 Years Type: European Stock Price: 120.0 Strike Price: 130.0 Risk Free Rate: 2% It is estimated that volatility will be 25% per annum over the next two years. Assume a two step tree (with each step representing one year, At=1.0): a) Using the following formulas: u=eloVAT) 1 d = U et - d p= u-d calculate u, d and p. [3 marks] b) Briefly, explain what u, d and p are. [3 marks] c) Using the u, d and p; calculated in a) draw a two-step tree and calculate the stock price at each node. [3 marks] d) Show the values of the Put Option at each of the three, two-year nodes. [3 marks] e) Using P, and discounting using exp(-rAt) work back through the tree to calculate the option value. [4 marks] QUESTION THREE This question concerns the two-step binomial tree method of pricing Options. You have the following information on a European Put Option: Expiry: 2 Years Type: European Stock Price: 120.0 Strike Price: 130.0 Risk Free Rate: 2% It is estimated that volatility will be 25% per annum over the next two years. Assume a two step tree (with each step representing one year, At=1.0): a) Using the following formulas: u=eloVAT) 1 d = U et - d p= u-d calculate u, d and p. [3 marks] b) Briefly, explain what u, d and p are. [3 marks] c) Using the u, d and p; calculated in a) draw a two-step tree and calculate the stock price at each node. [3 marks] d) Show the values of the Put Option at each of the three, two-year nodes. [3 marks] e) Using P, and discounting using exp(-rAt) work back through the tree to calculate the option value. [4 marks]