△=1

B=−91. 41
Price=38. 59
169
△=0.22 5
B=−13.8 6
Price=4.1 4

130

104
100

80
△=−0. 689
B=−49. 06
Price=19. 8 4

64
Solution: Maturity is 1 year but we need to construct 2-period binominal tree, each with half year.
Given value of u and d must be over a period of six month. If they are over the years, you need to
find over the six months. But I am not assuming that.

The actual way of finding u and d is given below

u=exp[σ √ Δt ],∧u=exp[−σ √ Δt ]where , Δt is 0.5 year ∈this case

is find
Given interest rate year ; we need ¿ months .
a six

¿
1
r =1.0 8 2 ) – 1=0.03923=3.923 %

Growth factor : R=1+ r=1.0392 3

Replicating Portfolio:
Make equation to replicate portfolio which consists of H number of shares and B amount invested on
Treasury bond.

Su H +(1+r ) B=Cu

Sd H +( 1+ r)B=Cd

H=(Cu – Cd)/( Su – Sd) , B=(Cu – Su H )/ R , C=S H + B

H isthe option delta∨hedge ration . It is also denoted by Δ .

Su=uS∧Sd=dS

C=max (S – K , 0)

(Cuu ,Cud ,Cdd)=(74 ,9 , 0)

At node u:

H=(74 – 9)/(169 – 104)=1 , B=(74 – 169∗1)/1.03923=−91.41

Cu=130∗1 – 91.41=38.59

Call premium=38.59

At node d:

H=(9 – 0)/(104 – 64 )=0.225

B=(9 – 104∗0.225)/1.03923=−13.86
Cd=Sd H + B=80∗0.225 – 13.86=4.14

Call premium=4.14

At node t =0

H=(38.59 – 4.14)/(130 – 80)=0.689

B=(38.59 – 130∗0.689)/1.03923=−49.06

C=100∗0.689 – 49.06=19.84

Call premium=$ 19.84

Similarly , you can find Put premium=7.80

Verify Put−Call parity

LHS=P+ S=7.80+100=107.80

RHS=C+ PV ( K )=19.84+95 /1.08=107.80