Question: Problem 1: Consider a one-period trinomial model with a bank account and a stock. The interest rate that characterizes the bank account is r =

Problem 1: Consider a one-period trinomial model with a bank account

Problem 1: Consider a one-period trinomial model with a bank account and a stock. The interest rate that characterizes the bank account is r = 25%, the initial price of the stock is so = $2 and the terminal price Si takes the values Si(wi) = $1, Si(w2) = $2, S1(w3) = $4. Answer the following questions: (i). Is the model arbitrage-free? (ii). Is the model complete? Consider the call option with strike K = $2 expiring at maturity. (iii). Specify the lower and upper bounds for the range of arbitrage-free prices. In other words, find the threshold prices v.

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