Problem:
A stock price is currently $50. Over each of the next two 3-month periods it is expected to go up by 7% or down by 5%. The risk-free interest rate is 5% per annum with continuous compounding. The strike price is $52 for a European call.
Required:
Question 1: Calculate u, d, and p for a two-step tree.
Question 2: Value the option using a two-step tree formula.
Question 3: Re-calculate the value of this call assuming the stock has a dividend yield of 3% per annum.
Note: Explain all steps comprehensively.