Question: 1. Consider a single-period binomial model with r = 1/3, Bo 1, So = 2, d = 5/4, 3/2, and p 1/2. (You can take

1. Consider a single-period binomial model with r

1. Consider a single-period binomial model with r = 1/3, Bo 1, So = 2, d = 5/4, 3/2, and p 1/2. (You can take the sample space 2 to be {w1,w2}, with wi corresponding to the stock price going "up", and w2 corresponding to the stock price going "down".) (a) Compute B1. (b) Compute S1 (w1) and S1(w2), and the probability of each outcome. (c) For the trading strategy y = (2,4), compute Vo(4), Vi (4)(w1), and V1 (4)(w2). (d) Let X be a European call option with strike price $2.50 and expiration time T = 1. (i) Find X (w1) and X(w2). (ii) Find the replicating strategy = (1, 1) for X (iii) Find the manufacturing cost for that strategy. That is, compute Vo(4). (e) Give an example of arbitrage opportunity if the claim X can be purchased for Co = 1/16 (dollars) at time 0

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