Consider a one-period binomial model, where the time-0 stock price is $100, and where the time-1...

 

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Consider a one-period binomial model, where the time-0 stock price is $100, and where the time-1 prices are either $120 or $95. That is, in the class notation, u = 1.2, d = .95. Suppose there exists a share-or-nothing put with strike K = $100. Its time-0 market price is $60. Thus the binomial tree looks as follows: S(1) 120 pA (1)=0 S(0) = 100 pA (0) = 60 - S(1) = 95 p14 (1)=95 The prices shown at time 0 are the actual market prices. It is also given that the one-period interest rate is 5%. That is, in the class notation, R = 1.05. Show that there is arbitrage. You need to elaborate on the transactions and the cash flow. (There is more than one way.) Consider a one-period binomial model, where the time-0 stock price is $100, and where the time-1 prices are either $120 or $95. That is, in the class notation, u = 1.2, d = .95. Suppose there exists a share-or-nothing put with strike K = $100. Its time-0 market price is $60. Thus the binomial tree looks as follows: S(1) 120 pA (1)=0 S(0) = 100 pA (0) = 60 - S(1) = 95 p14 (1)=95 The prices shown at time 0 are the actual market prices. It is also given that the one-period interest rate is 5%. That is, in the class notation, R = 1.05. Show that there is arbitrage. You need to elaborate on the transactions and the cash flow. (There is more than one way.)