Question: Consider a multiplicative binomial model with N = 3, r = 0, u = 1.2, d = 0.8 and S 0 = 100. At time

Consider a multiplicative binomial model with N = 3, r = 0, u = 1.2, d = 0.8 and S 0 = 100. At time t = 1 when S 1 = 120 a (european) call option with maturity at T = 3 and struck at 100 is quoted at 25. Is that a fair value? If yes explain why? If not explain why and explicitly dene an arbitrage strategy (you have to give details of the arbitrage strategy)

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To determine whether the quoted price of the European call option is fair or not we need to compare it with its theoretical value in the given multiplicative binomial model and consider the possibilit... View full answer

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