Question: Consider a one-period model with three states and two assets, a risk-free bond and a stock. Assume that
B0 = 100, BT = 105, S0 = 10, and ST ∈ {8, 9, 12}
(a) Determine if the model is arbitrage-free and complete.
(b) Find the general solution for the state prices: a unique solution if the market is complete, or a range of solutions if the market is incomplete.
(c) Consider a call option on the stock with strike price K = 10. Find the bid-ask spread at t = 0.
(d) Suppose the market price of the call option is zero. Construct an arbitrage portfolio.