Answer:
A. The parameters p and u are the same for both trees
Explanation:
Calculation of parameters of u(upper limit) and p(lower limit) for both index and stock:
1) INDEX
Current Value: 100
Volatality : 25%
Value can increase upto 100+25% = 125
Value can decrease to 100-25% = 75
U = Value after increase/current value = 125/100 = 1.25
P = Value after decrease/ current value = 75/100 = 0.75
2) STOCK
Current Value: 100
Volatality : 25%
Value can increase upto 100+25% = 125
Value can decrease to 100-25% = 75
U = Value after increase/current value = 125/100 = 1.25
P = Value after decrease/ current value = 75/100 = 0.75
---> The parameters U and P for both index and stock are same. This is because both the index and stock has same value and same volality rate. Therefore, stock move according to the index.
if index changes by certain percentage the stock also changes. Here in this case, volatality rate is same for both index and stock. Hence Parameters U and P are same for Index and Stock.