Question: Consider a two-period binomial model for the asset () over the next two years where (0)=36 and the asset has a constant growth multiplier =1.5

Consider a two-period binomial model for the asset () over the next two years where (0)=36 and the asset has a constant growth multiplier =1.5 for each year. Assume interest rates are zero and the asset pays no dividends.

(i) Calculate the risk-neutral conditional probabilities for each time period and hence derive the probabilities (1,2,3) of achieving each of the three final share prices at time =2 years.

(ii) What is the value of a European call option with strike =31?

(iii) Explain the relationship between this two-period model and the one-period model in part (a). Hence or otherwise, verify that the risk-neutral probabilities (1,2,3) satisfy the formulae for =(1,2,3) and verify the formula for the call option.

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