Question: Consider a two-step binomial tree model. The stock price starts at $100. At each step the stock price increases or decreases by 10%. The simple

Consider a two-step binomial tree model. The stock price starts at

Consider a two-step binomial tree model. The stock price starts at $100. At each step the stock price increases or decreases by 10%. The simple interest rate is 0.02 per time step. (a) Suppose a European call option has a strike price of $110. Construct a binomial tree that shows the stock price and the option price at each node. Also, show the amount of stock and risk-free asset held at each node by the replicating trading strategy. [35] (b) What are the risk neutral probabilities? [20] (c) Use the risk neutral probabilities to nd the initial price of a European call option with a strike price of $115. [20]

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