Question: Question 3 [20 marks] Consider the binomial model for an American call and put on a stock whose price is $90. The exercise price for

Question 3 [20 marks]

Consider the binomial model for an American call and put on a stock whose price is $90. The exercise price for both the put and the call is $65. The standard deviation of the stock returns is 25 percent per annum, and the risk-free rate is 6 percent per annum. The options expire in 120 days. The stock will pay a dividend equal to 4 percent of its value in 60 days.

(a) Draw the three-period stock tree and the corresponding trees for the call and the put. [7.5 marks]

(b) Compute the price of these options using the three-period trees. [7.5 marks]

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