Supposing that we have a stock with the following assumptions: -The risk free rate of return = 7% , using this rate we can borrow , lend , and discount. Current price = 100 . -Exercise price = 100 . A riskless portfolio will be formulated according to the put-call-parity equation , -The possibility the price of a stock will go up is “P”, can be calculated by: (1+r-d)/(u-d), According to the previous assumptions, we can start calculating the call price over 2 periods, and since this model is districted we should start by period one. The current stock price at time (0) is 100,we have 2 possibilities, the price will either go up by the u (1.5) factor to reach , 100(1.5)=150, or go down by d (0.5) to reach , 100(0.5)=50, at time 1. Whether go up or down, we can distinguish the stock price possibilities till the end of period 2 . Now we can calculate Call price at expiration according to the assumptions above, but before, we should know the intrinsic values at expiration : Cu2 = (225 – 100) = 125, So the call price at time 0 will be : A hedge portfolio could be created in this situation , as we mentioned above in the assumptions by put –call –parity ,This portfolio is supposed to generate risk free rate of return 7%, and consisted of long shares and short calls, in other words we have to purchase shares of stock and write calls. To complete this hedge we should precise the hedge ratio h , as we mentioned previously , h=?C?S this is for one period, for two periods, in addition to the mentioned h, we have to compute hu , hd ,as the stock price will go up or down in the second period the hedge ratio will change accordingly. h = CU- Cd / US - dS = (66.59 - 0)/(150 – 50) = 0.666 , this means that for the first period we need to buy 0.666 share for each ...