(c) Consider a ten-step binomial model.

(i) Assuming interest rates are constant over the life of the call, calculate the

return R over one time step.

(ii) Calculate the up and down factors u and d in this ten-step model.

(iii) Calculate the risk neutral probability in this ten-step model.

(iv) Construct a ten-step binomial pricing tree for the call and calculate its pre- mium.

2. An investor wants to compare premium prices of a European call calculated with the Black Scholes model with premium prices calculated with a binomial model. The call has strike priceK $19 and the $20 The yearly volatility of the underlying is estimated to be -0.55 The interest rate is r = 6% pa. The call expires in 90 days so T = 90/365 years. underlying asset is currently selling tor