You construct a one-period binomial tree to model the price movements of a stock.

You are given:

1. The length of one period is 6 months.
2. The current price of the stock is 100.
3. The stock pays dividends continuously at a rate proportional to its price. The dividend yield is 3%.

Suppose:

• u denotes one plus the rate of gain on the stock if the stock price goes up.
• d denotes one plus the rate of loss on the stock if the stock price goes down.
• r denotes the continuously compounded risk-free interest rate.

Which of the following parameters would give rise to an arbitrage opportunity?

1. u=1.011,d=0.822,r=0.05

2. u=1.021,d=0.981,r=0.06

3. u=1.025,d=1.002,r=0.07

4. u=1.028,d=1.010,r=0.08

5. u=1.029,d=1.022,r=0.09

PlEASE PROVIDE EXPLANATION