Consider a one-period, two state case in which XYZ stock is trading at So=$35, has u of 1.05and d of 1/1.05, and which the period risk-free rate is 2%.

Using the BOPM, determine the equilibrium price of an XYZ 35 European call option expiring at the end of the period.

Explain what an arbitrageur would do if the XYZ 3 European call was priced at $1.35. Show what arbitrageur’s cash flow would be at expiration when she closed.

Explain what an arbitrageur would do if the XYZ 35 European call was priced at $1.10. Show what arbitrageur’s cash flow would be at expiration when she closed.