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(a) Suppose that 9h = $120 and q; = $90. An investor uses the pest stock price dynamics to estimate that the probabilities of the stock price ql taking either of the values are 50:50. Therefore, she evaluates the current stock price as _ 0.5% +0.5}; _ 1_m _ so — 1+? — 1.1 —$95.44. The investor observes that the current price of the stock, is not $95.44, but $98.18, and decides that the stock is overpriced by the market. Is the investor right?r lib-[plain why or why not. b There is also the Euro ean call o tion on the stock with the strike $100 P P and maturity date at t = 1. What is the payoff on the option at t = 1? Create a replicating portfolio for the call and calculate the option price at t = 0. c Show that if the o tion rice is difierent from the value u found in P P 3"" (b), then it is possible to create an arbitrage portfolio. (d) Consider the American put option on the stock with the maturity date 1: = l and the strike 90 {I K {I 120. For which values of K the option will be exercised prematurely?
 

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Consider a two Period (+= 0.11 market with two assets: a risk free bond with face value $1 and rate of return r=0.1; and a Stock, whose current Price is go. The fiture Price q₁ is uncertain, and it can take one of the two values 91 €22h. 25}, where qh go (1+r) Sqs. 01-18-1 01.18 Consider a two Period (+= 0.11 market with two assets: a risk free bond with face value $1 and rate of return r=0.1; and a Stock, whose current Price is go. The fiture Price q₁ is uncertain, and it can take one of the two values 91 €22h. 25}, where qh go (1+r) Sqs. 01-18-1 01.18

Answer rating: 100% (QA)

a The investors calculation of the stock price based on the probabilities given is correct Current s... View the full answer