Question 8 Consider a two-period binomial model in which a stock currently trades at a price of R65. The stock price can go up 20% or down 17% each period. The risk-free rate is 5% per annum with continuous compounding. Assume that each period is 6 months. 8.1 Determine the risk-neutral probability of an up movement of the price during one period. [2] 8.2 If the strike price is R60, determine the value of the European put option using the risk-neutral probability and a two-period binomial tree. [8] 8.3 Find the number of units of the underlying stock that would be required at each node in the binomial tree to construct a risk-free hegde of 10 000 European put options. 191 Question 8 Consider a two-period binomial model in which a stock currently trades at a price of R65. The stock price can go up 20% or down 17% each period. The risk-free rate is 5% per annum with continuous compounding. Assume that each period is 6 months. 8.1 Determine the risk-neutral probability of an up movement of the price during one period. [2] 8.2 If the strike price is R60, determine the value of the European put option using the risk-neutral probability and a two-period binomial tree. [8] 8.3 Find the number of units of the underlying stock that would be required at each node in the binomial tree to construct a risk-free hegde of 10 000 European put options. 191