Compute the possible payoffs of the call option

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Suppose that, in each period, the cost of a security either goes up by a factor of u = 2 or down by a factor d = 1/2. Assume the initial price of the security is $100 and that the interest rate r is 0.

Problem a). Compute the risk neutral probabilities p (price moves up) and q = 1 - p (price moves down) for this model

Problem b). Assuming the strike price of a European call option on this security is $150, compute the possible payoffs of the call option given that the option expires in two periods. It may help to sketch a diagram of the possible security price movement over two periods.

Problem c). What is the expected value of the payoff of the call option?

Problem d). What should the no-arbitrage price of the call option be?

Reference no: EM132931158

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