A stock price is currently $40. The risk-free interest rate is 12% per annum with continuous compounding. Annual continuously compounded volatility is 10%. Construct a binomial tree for two periods and calculate the value of the options by working back through the binomial tree.
a) What is your replicating portfolio today for a 6-month European put option with a strike price of $42?
b) What is the value of a 6-month European put option with a strike price of $42?