You are given the following information concerning a stock denoted by St. Current value = 102.

Question:

You are given the following information concerning a stock denoted by St.
• Current value = 102.
• Annual volatility = 30%.
• You are also given the spot rate r = 5%, which is known to be constant during the next 3 months.
It is hoped that the dynamic behavior of St can be approximated reasonably well by a binomial process if one assumes observation intervals of length 1 month.
(a) Consider a European call option written on St. The call has a K = 120 and an expiration of 3 months. Using the St and the risk-free borrowing and lending Bt, construct a that replicates the option.
(b) Using the replicating price this call.
(c) Suppose you sell, over-the-counter, 100 such calls to your customers. How would you hedge this position? Be precise.
(d) Suppose the market price of this call is 5. How would you form an arbitrage Strike Price
In finance, the strike price of an option is the fixed price at which the owner of the option can buy, or sell, the underlying security or commodity. Portfolio
A portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non-publicly...