Question: 1. For a two-period binomial model, you are given: Each period is one year, the current price for a non-dividend-paying stock is 20. u =

1. For a two-period binomial model, you are given: Each period is one year, the current price for a non-dividend-paying stock is 20. u = 1.2840, where u is one plus the rate of capital gain on the stock per period if the stock price goes up. d = 0.8607, where d is one plus the rate of capital loss on the stock per period if the stock price goes down. The continuously compounded risk-free interest rate is 5%. Strike price is 22.

(i) Calculate the stock prices at various nodes.

(ii) Calculate the risk neutral probability.

(iii) If the option is exercised at time 2,

iv) calculate the value of the call.

2. Why is the risk-free rate important in Black-Scholes Model?

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