The following information is provided in the context of a two-year binomial option pricing model: A non-dividend paying stock currently trades at 40 per share. There is a call option on the stock with exercise price of 42. The stock can either rise by 16% or fall by 9% in each period. The one-year risk free rate is 3%. Answer the following questions:

a. Calculate the price of a European call option using the two-year binomial option pricing model explaining clearly every step you make and providing an interpretation of the model. (15 marks)

b. Using the same two steps binomial pricing model, what would be the price of this option if it were an American option instead of a European option?

(5 marks)

c. Briefly discuss the concept of risk neutrality that underlies the valuation of this option. (5 marks)