Question
You are using the binomial tree model (drawn and labelled below) to model a stock's price movements and price a 6-month European option on the
You are using the binomial tree model (drawn and labelled below) to model a stock's price movements and price a 6-month European option on the stock, which is trading at $25. The risk-free interest rate is 2% p.a.c.c. One period later, stock price in the down state will be $22. From there, when the stock price continues to go up, the option will expire worthless; when the stock price goes down instead, the option will expire with a value of $3.24.
a. Is this a call or a put?(1 mark)
b. Calculate the remaining stock prices and option values that correspond to every node on the tree. Complete working process must be shown for marks.(10 marks)
c. If the option is written on a futures contract, identify the adjustment you need to make in part (b), but don't re-calculate the values.(1 mark)
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