Question: Assume the binomial model framework. Consider the stock price process { : 0 3 } of a non-dividend paying stock. Let 0 = 100 and

Assume the binomial model framework. Consider the stock price process { : 0 3 } of a non-dividend paying stock. Let 0 = 100 and let the price rise or fall by 10 % at each timestep. The continuously compounded risk-free interest rate is r = 5% per annum. We wish to price a 3-year European put option with the strike price K = 110. You are given the following information: y is the number of shares in the stock. x is the number of units in a risk-free asset. The price of the risk-free asset is 0 = 7 and is expected to increase at a risk-free interest rate per annum. a) Using a 3-step binomial tree, determine the risk-neutral probability q of an up-step. [2] b) Display the price process of the stock on the binomial tree. [4.5] c) Using a 3-step binomial tree, display the price process of the option on the binomial tree and calculate the premium of the European put option. [8] d) Find the value of the replicating portfolio at the upper node of timestep 1 that can replicate the option

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