Calculate risk-neutral probability and portfolio composition

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Consider a 9-month American call option on a fictitious stock BlackIce with strike price $20. Current spot price is both $20. A continuously compounded ri sk-free interest rate is 2% and a continuously compounded dividend is 2%. Annualized volati lity of the stock price is 10%.

a. Estimate the price of the option using 3-period (4-date) b inomial tree. Indicate the nodes where the option is exercised. Calculate the risk-neutral probability and the portfolio composition ( ? and B ) at t = 0.

b. Consider an American put option with the same set of parame ters. Estimate the price of the option using 3-period (4-date) binomial tree. Indicate the nodes where the option is exercised. Calculate the risk-neutral probability and the portfolio composition ( ? and B ) at t = 0.

Reference no: EM131346591

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