2. Consider a three-period binomial tree model for the non-dividend paying stock price process Sr, in...
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2. Consider a three-period binomial tree model for the non-dividend paying stock price process Sr, in which the stock price either rises by u% or falls by d% each period till maturity. R=0.025 UCT- 2021 ECO 40538 Page 2 of 6 Question 2 continues on the next page.... (a) State the conditions under which this market is arbitrage free. Let So R950 and assume this price either rises or falls by 20% each year for the next three years. Assume also that the risk-free rate is 5% per annum continuously compounded. (b) Calculate the price of a European put option with maturity in three years and strike price 1100. [1 marks) (5 marks] 2. Consider a three-period binomial tree model for the non-dividend paying stock price process Sr, in which the stock price either rises by u% or falls by d% each period till maturity. R=0.025 UCT- 2021 ECO 40538 Page 2 of 6 Question 2 continues on the next page.... (a) State the conditions under which this market is arbitrage free. Let So R950 and assume this price either rises or falls by 20% each year for the next three years. Assume also that the risk-free rate is 5% per annum continuously compounded. (b) Calculate the price of a European put option with maturity in three years and strike price 1100. [1 marks) (5 marks]
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