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Question - The price of a stock A is currently €85. Let be P an European put option (long put) on stock A with an expiration date in 2 years and a strike price of K= €90. Suppose that there are two-time steps of one year, and in each time step the stock price either moves up by u=1.35 or down by d=0.7408. The probability by which the share moves up is p=0.5097. Suppose also that the risk-free interest rate in the market is r=0.05=5% p.a. A is not paying any dividends during the lifetime of the option.
a) Chart the possible price developments of stock A using the Cox/Ross/Rubinstein model. To do this, select a model with two-time steps, i.e., with a period length of 1 year.
b) Calculate the resulting put values at the expiration date.
c) Calculate the fair price of the put on stock A at t using the binomial model of Cox/Ross/Rubinstein. Make use of compound interest for your calculations.
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