Question: 3. Consider a one step binomial tree for the portfolio II AS - NB which is long A shares and short N bonds and the

3. Consider a one step binomial tree for the portfolio II AS - NB which is long A shares and short N bonds and the interest rater is constant. Assume that the portfolio must replicate the value of an option Vo at time t = 0, such that at time T. V is the value of the option if the share price moves up, and Va is the value if share price moves down. Derive the two equations for the value of the portfolio that replicates the value of the option when the share price moves up or down. Solve these equations to find the value of A and N, and use the fact that two investments with the same payoff must have the same value to derive a formula for Vo 3. Consider a one step binomial tree for the portfolio II AS - NB which is long A shares and short N bonds and the interest rater is constant. Assume that the portfolio must replicate the value of an option Vo at time t = 0, such that at time T. V is the value of the option if the share price moves up, and Va is the value if share price moves down. Derive the two equations for the value of the portfolio that replicates the value of the option when the share price moves up or down. Solve these equations to find the value of A and N, and use the fact that two investments with the same payoff must have the same value to derive a formula for Vo

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