Consider a financial model with two trading times

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Consider a financial model with two trading times {0,1}, a single stock S that pays no dividents, and a bank. At t=0, we can buy or sell any number of shares of the stock at the price S0 = $40 per share. at t=1 the value of one share of stock will be either $80 or $20. THe one period interest rate for loans or depositis between t=0 and t=1 is r = 25%. X is a portfolio holding one call option on the stock with strike price Kc = $45 and one put option on the stock with strike price Kp = $25.

a) Explain without constructing a replicating portfolio why 4<X0<28. FUlly justify any claims you make in your explanation.

b) Find a replicating strategy and use it to determine X0.

Reference no: EM131013173

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