F3. A European put option with strike price $45 matures in one year. The underlying asset has volatility 20% per annum, and the current spot price is $50. The risk-free interest rate is 5.60% per annum. Divide the one-year interval into two six-month intervals, and use the recombinant tree with $u = e^{sigma sqrt{delta t}}$ and $d = e^{-sigma sqrt{delta t}}$, where $r$ is the risk-free rate, $sigma$ is the volatility of the underlying, and $delta t$ is the time interval. Determine the put price. Describe the associated trading strategy. In other words, specify how many units of stock and how much debt you should hold at each node after rebalancing.
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At node 1: P1 = $45 V1 = 20% t1 = 1 year At node 2: P2 = $50 V2 = 20% t2 = 6 months Show more…
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