What are the payoffs at the final nodes of the tree

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Reference no: EM132652140

A stock price is currently $34. During each three-month period for the next six months it is expected to increase by 8% or decrease by 7%. The risk-free interest rate is 4%. Use a two-step tree to calculate the value of a derivative that pays off (max[(40-ST),0])2 where ST is the stock price in six months.

a. What are the payoffs at the final nodes of the tree?

b. Use no-arbitrage arguments (you need to show how to set up the riskless portfolios at the different nodes of the binomial tree).

Use risk-neutral valuation.

Reference no: EM132652140

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