Question: . Consider the N-step binomial asset pricing model with 0 < d < 1 + r < u. (a) Assume N = 3, S0 =

. Consider the N-step binomial asset pricing model with 0 < d < 1 + r < u.

(a) Assume N = 3, S0 = 100, r = 0.05, u = 1.10, and d = 0.90.

Calculate the price at time zero, V0, of the European call-option with strike price K = 87.00.

(b) If the observed market price of the option in part (a) is $25 give a specific arbitrage trading strategy to take advantage of any potential mis-pricing.

(c) Suppose you wish to earn a profit of $100,000 from implementing your arbitrage trading strategy from part (b). What are the sizes of your positions in the asset, option, and cash (bank account) at time zero?

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