a) Consider a binomial lattice model for a 2-month call option with an exercise price of 200. Suppose that the share price either goes up by 4% or down by 3% each month, that the risk-free continuously-compounded rate is % per month and that the current share price is also 200.

Use the formula above to estimate the value of the option.

b)

The market price of a security can be modelled by assuming that it will either increase by 12% or decrease by 15% each month, independently of the price movement in other months. No dividends are payable during the next two months. The continuously-compounded monthly risk-free rate of interest is 1%. The current market price of the security is 127 .

c)

1. Use the binomial model to calculate the value of a two-month European put option on the security with a strike price of 125 .
2. Calculate the value of a two-month American put option on the same security with the same strike price.
3. Calculate the value of a two-month American call option on the same security with the same strike price.