5. Current Stock price S(0) is $30; risk-free rate is 5%. There are two possible outcome...

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5. Current Stock price S(0) is $30; risk-free rate is 5%. There are two possible outcome in one year, stock price might go up 30% (to $39) or go down 30% (to $21). Consider both a call and a put with the same strike price of $30 and one year to maturity. а. probability to go down is about 10%. Compute the price of call and put and also expected returns on the stock, call, put and a straddle (combination of a call and put with same strike of $30) using the binomial tree model. (6) You estimate that the probability of stock price to go up is 90% and b. However you are not sure about your estimates of the probabilities and decide to check out your results under different scenarios. You write down the following scenarios (P is the probability of stock price to go up to $39): (18) Stock return Put return Straddle return Call P 1-P call price put price return 0.1 0.9 0.3 0.7 0.5 0.5 0.583335 0.416665 0.7 0.3 0.8 0.2 0.9 0.1 Optional question: What is your intuition on the expected returns on the call, the put and the straddle. (2) 5. Current Stock price S(0) is $30; risk-free rate is 5%. There are two possible outcome in one year, stock price might go up 30% (to $39) or go down 30% (to $21). Consider both a call and a put with the same strike price of $30 and one year to maturity. а. probability to go down is about 10%. Compute the price of call and put and also expected returns on the stock, call, put and a straddle (combination of a call and put with same strike of $30) using the binomial tree model. (6) You estimate that the probability of stock price to go up is 90% and b. However you are not sure about your estimates of the probabilities and decide to check out your results under different scenarios. You write down the following scenarios (P is the probability of stock price to go up to $39): (18) Stock return Put return Straddle return Call P 1-P call price put price return 0.1 0.9 0.3 0.7 0.5 0.5 0.583335 0.416665 0.7 0.3 0.8 0.2 0.9 0.1 Optional question: What is your intuition on the expected returns on the call, the put and the straddle. (2)

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