Question 2...... Total: 25 Suppose that there are only two possible market scenarios, in which the value now So of one share of Stock at time 1 is either S with probability p, or S with probability (1-p). Consider the price Co at time t = 0, of a call option with strike price K, and let r be the continuous risk free rate. (a) Show that if we do not have S KS- and S So e S ** then there would be an arbitrage opportunity. (b) Derive an expression for the replicating for a European call option written on the stock that expires at time 1 and has a strike price of K, where S.

Question 2 Total: 25 Suppose that there are only two possible market scenarios, in which the value now S0 of one share of Stock at time 1 is either S1 with probability p, or S2 with probability (1p). Consider the price C0 at time t=0, of a call option with strike price K, and let r be the continuous risk free rate. (a) Show that if we do not have S1KS2andS1S0erS2 then there would be an arbitrage opportunity. (b) Derive an expression for the replicating for a European call option written on the stock that expires at time 1 and has a strike price of K, where S3