Suppose the share price for stock ABC could only take two possible values one month from today. Specifically, the stock price would be $100 with 60% probability and $80 with 40% probability. The current stock price is $91.

We will build up to finding the no-arbitrage price of a call option on stock ABC with strike K =95 that expires exactly one month from now. Assume the annual risk-free rate is 2%.

(a) What is the payoff (Ou) of the call option one month from today if the stock price is $100 at that time? What is the payoff (Od) if the stock price is $80?

(b) What portfolio of $F of risk-free bond today and x shares of the underlying stock will replicate the call option? ($F is the present value of the risk free bond.)

(c) What is the no-arbitrage price of the call option?

(d) Given the call option trades for the price you found in part (c), what is the expected return for the call option in one month? What is the expected return for stock ABC in one month? (Hint: you will need to use the probabilities 60% and 40%).