3. A stock price is currently $100. It is known that after 3 months it will either go up by 10% or down by 10%. The stock pays no dividends. The risk-free interest rate is 8% per annum with continuous compounding. (a) Find the premium of a 3-month European call with a strike price of $105 by using a one-period binomial tree. (b) Suppose you observe that in the market, a 3-month call with a strike price of $105 is worth $3.5. What arbitrage would you undertake?

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Market Efficiency

Market efficiency refers to the market's ability to provide investors with all available information about investment options for buying and selling securities. Market efficiency reflects the true value of securities without undervaluing or overvaluing them. When the quality and quantity of information increase, the market becomes more efficient, allowing it to reduce arbitrage and obtain higher market returns from investment. In a well-functioning market, everyone receives all information completely and immediately at no cost. It opens up a plethora of opportunities for investors to access various investment options.