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The following illustrates how important it is to consider tailing factor in taking a correct hedge strategy. 0.5 marks for lling each blank> Suppose the

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The following illustrates how important it is to consider tailing factor in taking a correct hedge strategy. 0.5 marks for lling each blank> Suppose the current spot price is $3. With 50 percent of the probability, the spot price will increase or decrease by 1 dollar for rst year and then remain the same as shown In the graph below. t=0 t=1 t=2 PU=0.5 : 50:4 > 50-4 so=2 Pd=0.5 Please answer the following questions. (a) If the annual discrete compounding risk-free rate is 10%, and the cost of carry offsets the convenience yield exactly, then the future price is equal to the spot price. Please explain. [1 mark]

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