Exercise 3

a) Construct a binomial tree with two steps for one year and therefore three pay-off states after one year. The yearly standard deviation of returns is 35%. The starting value of the underlying asset is V0 = 20.

b) Value a call option with strike price X = 25 and a one year time to maturity according to the data under a). Assume that the risk-free interest rate is 4% p.a.

c) Assume now that after t = 0.5 an absolute dividend of 2 is paid in the up-state and 1 in the down-state. What are the state values of the underlying asset and for the call under b) at t = 1? Depict the solution in an appropriate binomial tree!

a) Construct a binomial tree with two steps for one year and therefore three pay-off states after one year. The yearly standard deviation of returns is 35%. The starting value of the underlying asset is V0=20. b) Value a call option with strike price X=25 and a one year time to maturity according to the data under a). Assume that the risk-free interest rate is 4% p.a. c) Assume now that after t=0.5 an absolute dividend of 2 is paid in the up-state and 1 in the down-state. What are the state values of the underlying asset and for the call under b) at t=1 ? Depict the solution in an appropriate binomial tree