The Financial Institution OMEGA in the sunny State of California is implementing the latest risk HEDGING techniques. The treasurer of the institution employs a Binomial Option methodology in order to pay its obligations in the good, and the bad state of nature respectively. However, his CEO Dr. Ding-Dong suffered a temporary lapse of memory and he forgot how to use this risk hedging technique.

a. Briefly explain to him what this latest technique is all about.

b. Employ a call option of 9 dollars, a multiplicative upward factor of 1.4, a

multiplicative downward factor of 0.8, a probability of 0.5 in every state of nature, a stock price of $90, and a striking price of $90 respectively and create a PERFECT HEDGE. The Risk-Free Rate is 5%.

c. What is the Optimum Hedge Ratio?

d. What is the intrinsic value of the option in the good and bad states

respectively?

e. Is the Call Option Overvalued or Undervalued?