Reference no: EM132643847
Wesfarmers Limited (WES) is an Australian company with diverse holdings, including retail, industry, etc.. It is Australia's largest private employer. Currently (i.e., t = 0), WES shares are trading at $48.17. You wish to purchase a European put on WES shares, with strike price $50.00, expiring after two time steps. Consider a two-step binomial model, with variable returns: R(0, 0) = 1.035 , R(1, 1) = 1.025 and R(1, 0) = 1.045 . Using crr notation, assume u = 1.14 and d = 1/u .
(a) Calculate the risk neutral probabilities π(0, 0), π(1, 1) and π(1, 0). (If you wish, you may present these results in a binomial pricing tree).
(b) Construct a two-step binomial pricing tree for the European put.
(c) A European call has the same strike price, underlying asset and time to expiry as the European put. Construct a two-step binomial pricing tree for the European call.
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