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A stock that is currently worth $100 will be worth either $115 or $90 next period. A 1-period zero coupon bond that pays a face amount of $100 next period costs $90. A 1-period European call option with a strike price of 100 costs c0 and a 1-period European put option with a strike price of 100 costs p0.
a) Consider a portfolio which consists of longing 1 call option and shorting 1 put option. Draw a tree diagram for the portfolio. Clearly explain your work.
b) Using the stock and bond, create a portfolio to replicate the portfolio from part (a). Draw a tree diagram for the portfolio. Clearly explain your work.
c) Using the 2 portfolios find the no arbitrage price of the portfolio in part (a).
d) What well known relationship are we making use of in this question?
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