Question: Consider a model with A(0) = 1, A(1) = 1.2, S(0) = 35 and S(1) given by S(1) = 40 with probability p s with

Consider a model with A(0) = 1, A(1) = 1.2, S(0) = 35 and S(1) given by

S(1) = 40 with probability p

s with probability q

48 with probability 1 p q

where p, q (0, 1) and s is a nonnegative number.

(a) Find s for which the model is arbitrage free?

(b) Is a put option with strike price 44 replicable if s = 20 ? If so, what is its price?

(c) Find s for which a call option with strike price 40 is replicable? For these s, find the price of the call option?

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