Assume that the current price of spot gold is 1200. In the next two periods the price of gold is expected to either go up by 5% or decline by 5% each period. The risk-free rate is 2% each period.
1. What is the value of a European call option on gold which matures in one period with a strike price of 1200? What is the hedge ratio? What is the value of a put option with the same strike price?
2. What is the value of a call option on gold which matures in two periods with a striking price of 1200? What are the hedge ratios? What is the value of a put option with the same strike? Compare the values of the options with the option values obtained in a.