We have a 2-state, 2-period world (i.e. t = 0, 1, 2). The current stock price is 100 and the risk-free rate each period is 5%. Each period the stock can either go up by 10% or down by 10%. A European call option on this stock with an exercise price of 90 expires at the end of the second period.

a. What are the values of the calls at maturity, t=2?

b. What are the values of the calls at t =1?

c. What is the initial (t = 0) fair market price of the call?

d. What is the initial (t = 0) hedge ratio?

e. What are the hedge ratios at t = 1?

f. If one call was written initially, what is the value of the hedged portfolio one period later (t = 1)?

g. If the stock moves down in period 1 how would you adjust your t = 0 hedge by trading only stock?