Problem:
Suppose today's stock price of Book.com is $100. With probability 60% the price will rise to $130 in one year and with probability 40% it will fall to $80 in one year. A European put option with a strike price of $90 and a time to expiration of one year sells at $4.
Required:
Question 1: What is the one-year risk free rate implied by no-arbitrage (hint draw a binomial tree as we did in class)?
Question 2: What would be the no-arbitrage risk free rate if with a probability of 50% the price increases and with a probability of 50% it decreases, keeping all other values constant?
Explain.