I'm finding it difficult to calculate the EMM as this problem comes with an interest earned on the account. How would I incoporate this into the working out?
Consider the following discrete time one-period market model. The savings account is 1 dollar at time 0, and 1.2 dollars at time 1. The stock price is given by S0 = 1 and S1 = alpha, where alpha is a random variable taking two possible values 1.3 and 0.8, each with positive probability.
a). Find with proof the EMM of this model. Does this model have arbitrage opportunities?
b). Consider a put option with exercise price K = 1 that expires at time 1. Find the replicating portfolio for this put option.
c). Compute the time 0 price of this unit option.
d). If the savings account at time 1 is $1.3 instead, does the model have an EMM?