(Mark Value = 5)

5. You are to price options on a futures contract. The movements of the futures price are modeled by a binomial tree. You are given:

1. i) Each period is 6 months.

2. ii) u/d = 4/3, where u is one plus the rate of gain on the futures price if it goes up, and d is one

   plus the rate of loss if it goes down.

3. iii) The risk-neutral probability of an up move is 1/3.

4. iv) The initial futures price is 80.

5. v) The continuously compounded risk-free interest rate is 5%.

Let CI be the price of a 1-year 85-strike European call option on the futures contract, and CII be the price of an otherwise identical American call option.

Determine CII CI. (This is Advanced Derivatives Questions (starting from page 40) #46. )