Suppose you have two stocks, ABC and XYZ. ABC costs $80 today, and will be worth $120 in the up state of the world and $40 in the down state. XYZ costs $95 today and will be worth $140 in the up state of the world and $60 in the down state. The states that govern stocks ABC and XYZ are the same, so they have the same true and risk-neutral probabilities. 

(a) What is the risk-free per-period interest rate? Write your answer in unit of percentage points. Assume continuous compounding. 

(b) What is the price today of the following portfolio: a put option on ABC with a strike of $100, a call option on ABC with a strike of $50, and a call option on XYZ with a strike of $70.

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To calculate the riskfree perperiod interest rate and the price of the portfolio we can use the concept of noarbitrage in a binomial model In this mod... View the full answer