Consider the following market model. A(0) = 10,A(1) = 12, S(0) = 30, and S(1) has...

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Consider the following market model. A(0) = 10,A(1) = 12, S(0) = 30, and S(1) has the following distribution S(1) = {40, with probability P p 30, with probability 1- p, where 0 < p < 1. 1. Argue that the model is arbitrage-free. 2. Consider an option maturing at t = 1 with the strike price K = 35. Prove that this option can be replicated and give its replicating portfolio. 3. Calculate the fair" price of this option (the price of this option such that the market ---constituted by stock, bonds, and this option--- is arbitrage free).\ Consider the following market model. A(0) = 10,A(1) = 12, S(0) = 30, and S(1) has the following distribution S(1) = {40, with probability P p 30, with probability 1- p, where 0 < p < 1. 1. Argue that the model is arbitrage-free. 2. Consider an option maturing at t = 1 with the strike price K = 35. Prove that this option can be replicated and give its replicating portfolio. 3. Calculate the fair" price of this option (the price of this option such that the market ---constituted by stock, bonds, and this option--- is arbitrage free).\

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To argue that the model is arbitragefree we need to show that there are no opportunities for riskfree profits In an arbitragefree market it is not pos... View the full answer